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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Quarterly Period Ended June 30, 2014

or

 

¨ Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Transition Period from                      to                     

Commission File Number: 000-54295

 

 

Sterling Real Estate Trust

(Exact name of registrant as specified in its charter)

 

 

 

North Dakota   90-0115411

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

1711 Gold Drive South, Suite 100, Fargo, North Dakota   58103
(Address of principal executive offices)   (Zip Code)

(701) 353-2720

(Registrant’s telephone number, including area code)

INREIT Real Estate Investment Trust

(Former name, former address and formal fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class

  

Outstanding at August 7, 2014

Common Shares of Beneficial Interest, $0.01 par value per share    5,506,418.7256

 

 

 


Table of Contents

STERLING REAL ESTATE TRUST

INDEX

 

     Page  
     No.  
PART I. FINANCIAL INFORMATION   

Item 1. Financial Statements (unaudited):

  

Consolidated Balance Sheets – as of June 30, 2014 and December 31, 2013

     3   

Consolidated Statements of Operations and Other Comprehensive Income – Three and six months ended June 30, 2014 and 2013

     4   

Consolidated Statement of Shareholders’ Equity – Six months ended June 30, 2014

     6   

Consolidated Statements of Cash Flows – Six months ended June 30, 2014 and 2013

     7   

Notes to Consolidated Financial Statements

     9   

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     39   

Item 4. Controls and Procedures

     51   
PART II. OTHER INFORMATION   

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     52   

Item 6. Exhibits

     54   

Signatures

  


Table of Contents

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

AS OF JUNE 30, 2014 (UNAUDITED) AND DECEMBER 31, 2013

 

     June 30,     December 31,  
     2014     2013  
     (unaudited)        
     (in thousands)  

ASSETS

    

Real estate investments

   $ 419,579      $ 403,192   

Cash and cash equivalents

     785        13,849   

Restricted deposits and funded reserves

     7,801        5,585   

Investment in unconsolidated affiliates

     9,171        7,366   

Due from related party

     5        64   

Receivables

     2,876        3,517   

Prepaid expenses

     580        1,209   

Investment in marketable securities

     7,676        —     

Financing and lease costs, less accumulated amortization of $2,616 in 2014 and $2,240 in 2013

     2,638        2,950   

Intangible assets, less accumulated amortization of $4,331 in 2014 and $3,720 in 2013

     9,868        10,479   

Other assets

     420        89   
  

 

 

   

 

 

 

Total Assets

   $ 461,399      $ 448,300   
  

 

 

   

 

 

 

LIABILITIES

    

Mortgage notes payable

   $ 238,740      $ 239,008   

Lines of credit

     1,422        —     

Special assessments payable

     920        784   

Dividends payable

     4,483        3,990   

Due to related party

     469        294   

Tenant security deposits payable

     2,483        2,305   

Investment certificates

     367        364   

Unfavorable leases, less accumulated amortization of $504 in 2014 and $432 in 2013

     881        953   

Accounts payable—trade

     1,130        403   

Retainage payable

     292        133   

Fair value of interest rate swaps

     307        309   

Deferred insurance proceeds

     123        —     

Accrued expenses and other liabilities

     3,477        2,551   
  

 

 

   

 

 

 

Total Liabilities

     255,094        251,094   
  

 

 

   

 

 

 

COMMITMENTS and CONTINGENCIES—Note 18

    

SHAREHOLDERS’ EQUITY

    

Noncontrolling interest in operating partnership

     152,723        141,539   

Beneficial interest

     53,889        55,976   

Accumulated comprehensive loss

     (307     (309
  

 

 

   

 

 

 

Total Shareholders’ Equity

     206,305        197,206   
  

 

 

   

 

 

 
   $ 461,399      $ 448,300   
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements

 

3


Table of Contents

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND OTHER COMPREHENSIVE INCOME

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2014 AND 2013 (UNAUDITED)

 

     Three Months Ended      Six Months Ended  
     June 30,      June 30,  
     2014      2013      2014      2013  
     (in thousands)      (in thousands)  

Income from rental operations

     

Real estate rental income

   $ 16,734       $ 13,965       $ 33,258       $ 27,678   

Tenant reimbursements

     528         928         1,088         1,852   
  

 

 

    

 

 

    

 

 

    

 

 

 
     17,262         14,893         34,346         29,530   

Expenses

           

Expenses from rental operations

           

Interest

     3,082         2,661         6,146         5,354   

Depreciation and amortization

     3,377         2,962         6,732         5,801   

Real estate taxes

     1,262         1,622         2,577         3,222   

Property management fees

     1,610         1,254         3,168         2,434   

Utilities

     1,410         1,077         3,117         2,272   

Repairs and maintenance

     2,674         1,515         5,025         2,900   

Insurance

     402         255         800         499   
  

 

 

    

 

 

    

 

 

    

 

 

 
     13,817         11,346         27,565         22,482   

Administration of REIT

           

Administrative expenses

     98         101         164         142   

Advisory fees

     448         356         891         701   

Acquisition expenses

     689         675         1,050         1,562   

Trustee fees

     10         9         24         22   

Legal and accounting

     65         129         225         340   
  

 

 

    

 

 

    

 

 

    

 

 

 
     1,310         1,270         2,354         2,767   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total expenses

     15,127         12,616         29,919         25,249   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income from operations

   $ 2,135       $ 2,277       $ 4,427       $ 4,281   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

See Notes to Consolidated Financial Statements

 

4


Table of Contents

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND OTHER COMPREHENSIVE INCOME

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2014 AND 2013 (UNAUDITED) (Continued)

 

     Three Months Ended      Six Months Ended  
     June 30,      June 30,  
     2014     2013      2014      2013  
     (in thousands, except per share data)      (in thousands, except per share data)  

Income from operations

   $ 2,135      $ 2,277       $ 4,427       $ 4,281   

Other income

          

Equity in income of unconsolidated affiliates

     228        191         475         361   

Dividend and interest income

     101        7         158         15   

Gain on involuntary conversion

     —          —           24         —     

Gain on trading securities

     330        —           575         —     
  

 

 

   

 

 

    

 

 

    

 

 

 
     659        198         1,232         376   

Income from continuing operations

     2,794        2,475         5,659         4,657   

Discontinued operations

     —          281         —           530   
  

 

 

   

 

 

    

 

 

    

 

 

 

Net income

   $ 2,794      $ 2,756       $ 5,659       $ 5,187   
  

 

 

   

 

 

    

 

 

    

 

 

 

Net income attributable to noncontrolling interest

     2,017        1,922         4,085         3,606   
  

 

 

   

 

 

    

 

 

    

 

 

 

Net income attributable to Sterling Real Estate Trust

   $ 777      $ 834       $ 1,574       $ 1,581   
  

 

 

   

 

 

    

 

 

    

 

 

 

Earnings per common share, basic and diluted:

          

Continued operations

     0.14      $ 0.14         0.29       $ 0.27   

Discontinued operations

     —          0.02         —           0.03   
  

 

 

   

 

 

    

 

 

    

 

 

 

Net income per common share, basic and diluted

   $ 0.14      $ 0.16       $ 0.29       $ 0.30   
  

 

 

   

 

 

    

 

 

    

 

 

 

Comprehensive income:

          

Net income

   $ 2,794      $ 2,756       $ 5,659       $ 5,187   

Other comprehensive income—change in fair value of interest rate swaps

     (7     107         2         142   
  

 

 

   

 

 

    

 

 

    

 

 

 

Comprehensive income

     2,787        2,863         5,661         5,329   

Comprehensive income attributable to noncontrolling interest

     2,011        1,998         4,086         3,706   
  

 

 

   

 

 

    

 

 

    

 

 

 

Comprehensive income attributable to Sterling Real Estate Trust

   $ 776      $ 865       $ 1,575       $ 1,623   
  

 

 

   

 

 

    

 

 

    

 

 

 

See Notes to Consolidated Financial Statements

 

5


Table of Contents

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

FOR THE SIX MONTHS ENDED JUNE 30, 2014 (UNAUDITED)

 

          Common     Accumulated     Total           Accumulated        
    Common     Shares     Earnings     Beneficial     Noncontrolling     Comprehensive        
    Shares     Amount     (Deficit)     Interest     Interest     Loss     Total  
    (in thousands)  

BALANCE, DECEMBER 31, 2013

    5,454      $ 68,051      $ (12,075   $ 55,976      $ 141,539      $ (309   $ 197,206   

Contribution of assets in exchange for the issuance of noncontrolling interest shares

            14,396          14,396   

Shares/units redeemed

    (203     (2,836       (2,836     (976       (3,812

Dividends declared

        (2,436     (2,436     (6,387       (8,823

Dividends reinvested - stock dividend

    114        1,568          1,568            1,568   

Issuance of shares under optional purchase plan

    56        811          811            811   

UPREIT units converted to REIT common shares

    2        23          23        (23       —     

Purchase of subsidary ownership from noncontrolling interest

      (791     —          (791     100          (691

Increase in fair value of interest rate swaps

              2        2   

Distributions paid to consolidated real estate entity noncontrolling interests

            (11       (11

Net income

        1,574        1,574        4,085          5,659   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

BALANCE, JUNE 30, 2014

    5,423      $ 66,826      $ (12,937   $ 53,889      $ 152,723      $ (307   $ 206,305   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See Notes to Consolidated Financial Statements

 

6


Table of Contents

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED JUNE 30, 2014 AND 2013 (UNAUDITED)

 

     Six Months Ended  
     June 30,  
     2014     2013  
     (in thousands)  

OPERATING ACTIVITIES

    

Net income

   $ 5,659      $ 5,187   

Adjustments to reconcile net income to net cash from operating activities

    

Gain on sale of real estate

     —          (37

Net gain on investment in marketable securities

     (524     —     

Equity in income of unconsolidated affiliates

     (475     (361

Depreciation

     5,821        5,292   

Amortization

     911        909   

Effects on operating cash flows due to changes in

    

Tenant security deposits

     (172     (211

Due from related party

     59        337   

Receivables

     641        (183

Prepaid expenses

     629        423   

Marketable securities

     (7,152     —     

Other assets

     (321     (214

Due to related party

     175        47   

Tenant security deposits payable

     178        242   

Accounts payable

     (263     (37

Accrued expenses

     906        1,244   
  

 

 

   

 

 

 

NET CASH PROVIDED BY OPERATING ACTIVITIES

     6,072        12,638   
  

 

 

   

 

 

 

INVESTING ACTIVITIES

    

Purchase of real estate investment properties

     (4,135     (15,081

Capital expenditures and tenant improvements

     (3,705     (843

Proceeds from sale of real estate investments

     —          276   

Proceeds from involuntary conversion

     47        —     

Investment in unconsolidated affiliates

     (647     (213

Distributions received from unconsolidated affiliates

     632        420   

Real estate tax, insurance and replacement reserve escrows

     (2,045     (2,533

Notes receivable payments received

     —          4   

Deferred insurance proceeds

     120        98   
  

 

 

   

 

 

 

NET CASH USED IN INVESTING ACTIVITIES

     (9,733     (17,872
  

 

 

   

 

 

 

 

See Notes to Consolidated Financial Statements

 

7


Table of Contents

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED JUNE 30, 2014 AND 2013 (UNAUDITED) (Continued)

 

     Six Months Ended  
     June 30,  
     2014     2013  
     (in thousands)  

FINANCING ACTIVITIES

  

Payments for financing costs

     (70     —     

Payments on investment certificates

     (6     (300

Reinvested proceeds from investment certificates

     8        —     

Principal payments on special assessments payable

     (11     (6

Proceeds from issuance of mortgage notes payable

     2,863        19,010   

Principal payments on mortgage notes payable

     (3,835     (12,934

Net change in lines of credit

     1,422        6,001   

Proceeds from issuance of shares under optional purchase plan

     811        401   

Shares/units redeemed

     (3,812     (2,126

Dividends/distributions paid

     (6,773     (5,799

Payment of syndication costs

     —          (67
  

 

 

   

 

 

 

NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES

     (9,403     4,180   
  

 

 

   

 

 

 

NET CHANGE IN CASH AND CASH EQUIVALENTS

     (13,064     (1,054

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD

     13,849        4,556   
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS AT END OF PERIOD

   $ 785      $ 3,502   
  

 

 

   

 

 

 

SCHEDULE OF CASH FLOW INFORMATION

    

Cash paid during the period for interest, net of capitalized interest

   $ 6,184      $ 5,618   
  

 

 

   

 

 

 

SUPPLEMENTARY SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES

    

Dividends reinvested

   $ 1,568      $ 1,363   

Dividends declared and not paid

     1,220        1,123   

UPREIT distributions declared and not paid

     3,263        2,586   

UPREIT units converted to REIT common shares

     23        —     

Acquisition of assets in exchange for the issuance of noncontrolling interest units in UPREIT

     13,706        17,555   

Contributed assets in real estate venture

     1,316        —     

Purchase of subsidiary ownership from noncontrolling interest in exchange for the issuance of noncontrolling interest units in UPREIT

     791        —     

Increase in land improvements due to increase in special assessments payable

     135        122   

Unrealized gain on interest rate swaps

     (2     (142

Acquisition of assets through assumption of debt and liabilities and property purchased with financing

     740        —     

Acquisition of assets with accounts payable

     1,149        282   

See Notes to Consolidated Financial Statements

 

8


Table of Contents

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

NOTE 1 – ORGANIZATION

Sterling Real Estate Trust f/k/a INREIT Real Estate Investment Trust (“Sterling”) is a registered, but unincorporated business trust organized in North Dakota in November 2002. Sterling has elected to be taxed as a Real Estate Investment Trust (“REIT”) under Sections 856-860 of the Internal Revenue Code, which requires that 75% of the assets of a REIT must consist of real estate assets and that 75% of its gross income must be derived from real estate. The net income of the REIT is allocated in accordance with the stock ownership in the same fashion as a regular corporation.

Sterling previously established an operating partnership (“Sterling Properties, LLLP” f/k/a INREIT Properties, LLLP) and transferred all of its assets and liabilities to the operating partnership in exchange for general partnership units. As the general partner, Sterling has management responsibility for all activities of the operating partnership. As of June 30, 2014 and December 31, 2013, Sterling owned approximately 27.2% and 28.7%, respectively, of the operating partnership. The operating partnership is the 100% owner of 38 single asset limited liability companies.

NOTE 2 – PRINCIPAL ACTIVITY AND SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2013, which have previously been filed with the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted from this report on Form 10-Q pursuant to the rules and regulations of the SEC.

The results for the interim periods shown in this report are not necessarily indicative of future financial results. The accompanying consolidated balance sheet as of June 30, 2014 and consolidated statements of operations and other comprehensive income, consolidated statements of shareholders’ equity, and consolidated statements of cash flows for the three and six month periods ended June 30, 2014 and 2013, as applicable, have not been audited by our independent registered public accounting firm. In the opinion of management, the accompanying unaudited consolidated financial statements include all adjustments necessary to present fairly our consolidated financial position as of June 30, 2014 and our consolidated statements of operations and other comprehensive income, consolidated statements of shareholders’ equity and our consolidated cash flows for the six month periods ended June 30, 2014 and 2013, as applicable. These adjustments are of a normal recurring nature.

Principles of Consolidation

The consolidated financial statements include the accounts of Sterling, Sterling Properties, LLLP, and 38 single asset limited liability companies. All significant intercompany transactions and balances have been eliminated in consolidation.

Additionally, we evaluate the need to consolidate affiliates based on standards set forth in the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810, Consolidation (“ASC 810”). In determining whether we have a requirement to consolidate the accounts of an entity, management considers factors such as our ownership interest, our authority to make decisions and contractual and substantive participating rights of the limited partners and shareholders, as well as whether the entity is a variable interest entity (“VIE”) for which we have both a) the power to direct the activities of the VIE that most significantly impact the entity’s economic performance and b) the obligation to absorb losses or the right to receive benefits from the VIE that could be potentially significant to the VIE.

 

9


Table of Contents

STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

Principal Business Activity

Sterling currently owns directly and indirectly 129 properties. The trust’s 81 residential properties are located in North Dakota, Minnesota, and Nebraska and are principally multi-family apartment buildings. The trust owns 48 commercial properties primarily located in North Dakota with others located in Arkansas, Colorado, Iowa, Louisiana, Michigan, Minnesota, Mississippi, Nebraska, Texas and Wisconsin. The commercial properties include retail, office, industrial, restaurant and medical properties. Presently, the trust’s mix of properties are 65.7% residential and 34.3% commercial (based on cost) and total $419,579 in real estate investments at June 30, 2014.

 

Residential Property

   Location    No. of Properties      Units  
   North Dakota      70         4,590   
   Minnesota      9         1,453   
   Nebraska      2         316   
     

 

 

    

 

 

 
        81         6,359   

Commercial Property

   Location    No. of Properties      Sq Ft  
   North Dakota      20         810,496   
   Arkansas      2         29,370   
   Colorado      1         13,390   
   Iowa      1         32,532   
   Louisiana      1         14,560   
   Michigan      1         11,737   
   Minnesota      13         360,306   
   Mississippi      1         14,820   
   Nebraska      1         14,736   
   Texas      1         7,296   
   Wisconsin      6         74,916   
     

 

 

    

 

 

 
        48         1,384,159   

Investment in Unconsolidated Affiliates

We account for unconsolidated affiliates using the equity method of accounting per guidance established under ASC 323, Investments – Equity Method and Joint Ventures (“ASC 323”). The equity method of accounting requires the investment to be initially recorded at cost and subsequently adjusted for our share of equity in the affiliates’ earnings and distributions. We evaluate the carrying amount of the investments for impairment in accordance with ASC 323. Unconsolidated affiliates are reviewed for potential impairment if the carrying amount of the investment exceeds its fair value. An impairment charge is recorded when an impairment is deemed to be other-than-temporary. To determine whether impairment is other-than-temporary, we consider whether we have the ability and intent to hold the investment until the carrying amount is fully recovered. The evaluation of an investment in an affiliate for potential impairment can require our management to exercise significant judgments. No impairment losses were recorded related to the unconsolidated affiliates for the three and six months ended June 30, 2014 and 2013.

The operating partnership owns a 40.26% interest in a single asset limited liability company which owns a 144 unit residential, multi-family apartment complex in Bismarck, North Dakota. The property is encumbered by a first mortgage with a balance at June 30, 2014 and December 31, 2013 of $2,354 and $2,383, respectively. We owed $948 and $960 of our respective share of the mortgage loan balance as of June 30, 2014 and December 31, 2013, respectively. However, the Company is jointly and severally liable for the full mortgage balance.

 

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

The operating partnership is a 50% owner of Grand Forks Marketplace Retail Center through 100% ownership in a limited liability company. Grand Forks Marketplace Retail Center has approximately 183,000 square feet of commercial space in Grand Forks, North Dakota. The property is encumbered by a non-recourse first mortgage with a balance at June 30, 2014 and December 31, 2013 of $11,346 and $11,432, respectively. We owed $5,673 and $5,716 for our respective share of the mortgage loan balance as of June 30, 2014 and December 31, 2013, respectively. However, the Company is jointly and severally liable for the full mortgage balance.

The operating partnership owns a 66.67% interest as tenant in common in an office building with approximately 75,000 square feet of commercial rental space in Fargo, North Dakota. The property is encumbered by a first mortgage with a balance at June 30, 2014 and December 31, 2013 of $7,286 and $7,349, respectively. We owed $4,857 and $4,899 for our respective share of the mortgage loan balance on June 30, 2014 and December 31, 2013, respectively. However, the Company is jointly and severally liable for the full mortgage balance.

The operating partnership owns an 82.50% interest as a tenant in common in a 61 unit residential, multi-family apartment complex in Fargo, North Dakota. The property was unencumbered at June 30, 2014 and December 31, 2013, respectively.

The operating partnership is a 99% owner of Michigan Street Transit Center, LLC (“Transit Center”) through 100% ownership in a limited liability company. The operating partnership has contributed approximately $644 in cash and $1,316 in property contributions to the Transit Center in May and June 2014, respectively. As of June 30, 2014, the property owned by the Transit Center consisted of a building and parking ramp in Duluth, Minnesota which were intended to be demolished. The property was unencumbered at June 30, 2014 and December 31, 2013, respectively.

We use the equity method to account for investments that qualify as variable interest entities where we are not the primary beneficiary and entities that we do not control or where we do not own a majority of the economic interest but have the ability to exercise significant influence over the operations and financial policies of the investee. We will also use the equity method for investments that do not qualify as variable interest entities and do not meet the control requirements for consolidation, as defined in ASC 810. For a joint venture accounted for under the equity method, our share of net earnings and losses is reflected in income when earned and distributions are credited against our investment in the joint venture as received.

In determining whether a joint venture is a variable interest entity, we consider: the form of our ownership interest and legal structure; the size of our investment; the financing structure of the entity, including the necessity of subordinated debt; estimates of future cash flows; ours and our partner’s ability to participate in the decision making related acquisitions, dispositions, budgeting and financing on the entity; and obligation to absorb losses and preferential returns. As of June 30, 2014, we assessed one of our joint venture arrangements as a variable interest entity where we were not the primary beneficiary. In addition, four of our joint venture arrangements do not qualify as variable interest entities and do not meet the control requirements for consolidation, as defined in ASC 810.

As of June 30, 2014 and December 31, 2013, the unconsolidated affiliates held total assets of $30,561 and $31,289 and mortgage notes payable of $20,986 and $21,164, respectively.

Concentration of Credit Risk

Our cash balances are maintained in various bank deposit accounts. The bank deposit amounts in these accounts may exceed federally insured limits at various times throughout the year.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

Real Estate Investments

We account for our property acquisitions by allocating the purchase price of a property to the property’s assets based on management’s estimates of fair value. Techniques used to estimate fair value include, but are not limited to, appraisals of the properties by a certified independent appraiser at the time of acquisition.

Furniture and fixtures are stated at cost less accumulated depreciation. All costs associated with the development and construction of real estate investments, including acquisition fees and interest, are capitalized as a cost of the property. Expenditures for renewals and improvements that significantly add to the productive capacity or extend the useful life of an asset are capitalized. Expenditures for routine maintenance and repairs, which do not add to the value or extend useful lives, are charged to expense as incurred.

Depreciation is provided for over the estimated useful lives of the individual assets using the straight-line method over the following estimated useful lives:

 

Buildings and improvements

     40 years   

Furniture and fixtures

     9 years   

Depreciation expense for the three months ended June 30, 2014 and 2013 totaled $2,937 and $2,706, respectively.

Depreciation expense for the six months ended June 30, 2014 and 2013 totaled $5,821 and $5,292, respectively.

The Company’s investment properties are reviewed for potential impairment at the end of each reporting period whenever events or changes in circumstances indicate that the carrying value may not be recoverable. At the end of each reporting period, the Company separately determines whether impairment indicators exist for each property.

Examples of situations considered to be impairment indicators include, but are not limited to:

 

    a substantial decline or continued low occupancy rate;

 

    continued difficulty in leasing space;

 

    significant financial troubled tenants;

 

    a change in plan to sell a property prior to the end of its useful life or holding period;

 

    a significant decrease in market price not in line with general market trends; and

 

    any other quantitative or qualitative events or factors deemed significant by the Company’s management or board of trustees.

If the presence of one or more impairment indicators as described above is identified at the end of the reporting period or throughout the year with respect to an investment property, the asset is tested for recoverability by comparing its carrying value to the estimated future undiscounted cash flows. An investment property is considered to be impaired when the estimated future undiscounted cash flows are less than its current carrying value. When performing a test for recoverability or estimating the fair value of an impaired investment property, the Company makes complex or subjective assumptions which include, but are not limited to:

 

    projected operating cash flows considering factors such as vacancy rates, rental rates, lease terms, tenant financial strength, demographics, holding period and property location;

 

    projected capital expenditures and lease origination costs;

 

    projected cash flows from the eventual disposition of an operating property using a property specific capitalization rate;

 

    comparable selling prices; and

 

    property specific discount rates for fair value estimates as necessary.

 

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

To the extent impairment has occurred, the Company will record an impairment charge calculated as the excess of the carrying value of the asset over its fair value for impairment of investment properties. Based on evaluation, there were no impairment losses during the three or six months ended June 30, 2014 and 2013, respectively.

Properties Held for Sale

We account for our properties held for sale in accordance with ASC 360, Property, Plant and Equipment (“ASC 360”), which addresses financial accounting and reporting in a period in which a component of an entity either has been disposed of or is classified as held for sale, and requires that the statements of operations for current and prior periods shall report the results of operations of the component as discontinued operations.

In accordance with ASC 360, at such time as a property is held for sale, such property is carried at the lower of (1) its carrying amount or (2) fair value less costs to sell. In addition, a property being held for sale ceases to be depreciated. We classify operating properties as properties held for sale in the period in which all of the following criteria are met:

 

    management, having the authority to approve the action, commits to a plan to sell the asset;

 

    the asset is available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such assets;

 

    an active program to locate a buyer and other actions required to complete the plan to sell the asset has been initiated;

 

    the sale of the asset is probable and the transfer of the asset is expected to qualify for recognition as a completed sale within one year;

 

    the asset is being actively marketed for sale at a price that is reasonable in relation to its current fair value; and

 

    given the actions required to complete the plan to sell the asset, it is unlikely that significant changes to the plan would be made or that the plan would be withdrawn.

There were no properties classified as held for sale at June 30, 2014 or December 31, 2013. See Note 19.

Cash and Cash Equivalents

We classify highly liquid investments with a maturity of three months or less when purchased as cash equivalents.

Receivables

Receivables consist primarily of amounts due for rent and real estate taxes. The receivables are non-interest bearing. The carrying amount of receivables is reduced by an amount that reflects management’s best estimates of the amounts that will not be collected. As of June 30, 2014 and December 31, 2013, management determined no allowance was necessary for uncollectible receivables.

Investment in Marketable Securities

Investments in marketable securities are classified as trading consistent with the Company’s overall investment objectives and activities. Accordingly, all unrealized gains and losses on the Company’s marketable securities investment portfolio are included in the consolidated statements of operations and other comprehensive income.

Gross gains and losses on the sale of marketable securities are based on the first-in first-out method of determining cost.

Financing and Lease Costs

Financing costs incurred in connection with financing have been capitalized and are being amortized over the life of the financing using the effective interest method. Lease costs incurred in connection with new leases have been capitalized and are being amortized over the life of the lease using the straight-line method.

 

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

Intangible Assets

Lease intangibles are a purchase price allocation recorded on property acquisition. The lease intangibles represent the estimated value of in-place leases and the value of leases with above or below market lease terms. Lease intangibles are amortized over the term of the related lease.

The carrying amount of intangible assets is regularly reviewed for indicators of impairments in value. Impairment is recognized only if the carrying amount of the intangible asset is considered to be unrecoverable from its undiscounted cash flows and is measured as the difference between the carrying amount and the estimated fair value of the asset. Based on the review, management determined no impairment charges were necessary at June 30, 2014 and 2013.

Noncontrolling Interest

Interests in the operating partnership held by limited partners are represented by operating partnership units. The operating partnership’s income is allocated to holders of units based upon the ratio of their holdings to the total units outstanding during the period. Capital contributions, distributions, syndication costs, and profits and losses are allocated to noncontrolling interests in accordance with the terms of the operating partnership agreement.

Syndication Costs

Syndication costs consist of costs paid to attorneys, accountants, and selling agents, related to the raising of capital. Syndication costs are recorded as a reduction to beneficial and noncontrolling interest.

Federal Income Taxes

We have elected to be taxed as a REIT under the Internal Revenue Code, as amended. A REIT calculates taxable income similar to other domestic corporations, with the major difference being a REIT is entitled to a deduction for dividends paid. A REIT is generally required to distribute each year at least 90% of its taxable income. If it chooses to retain the remaining 10% of taxable income, it may do so, but it will be subject to a corporate tax on such income. REIT shareholders are taxed on REIT distributions of ordinary income in the same manner as they are taxed on other corporate distributions.

We intend to continue to qualify as a REIT and, as such, will not be taxed on the portion of the income that is distributed to the shareholders. In addition, we intend to distribute all of our taxable income; therefore, no provisions or liabilities for income taxes have been recorded in the financial statements.

Sterling conducts its business activity as an Umbrella Partnership Real Estate Investment Trust (“UPREIT”) through its Operating Partnership – Sterling Properties, LLLP. The Operating Partnership is organized as a limited liability limited partnership. Income or loss is allocated to the partners in accordance with the provisions of the Internal Revenue Code 704(b) and 704(c). UPREIT status allows non-recognition of gain by an owner of appreciated real estate if that owner contributes the real estate to a partnership in exchange for a partnership interest. The conversion of a partnership interest to shares of beneficial interest in the REIT will be a taxable event to the limited partner.

We follow ASC Topic 740, Income Taxes, to recognize, measure, present and disclose in our consolidated financial statements uncertain tax positions that we have taken or expect to take on a tax return. As of June 30, 2014 and December 31, 2013 we did not have any liabilities for uncertain tax positions that we believe should be recognized in our consolidated financial statements. We are no longer subject to Federal and State tax examinations by tax authorities for years before 2010.

The operating partnership has elected to record related interest and penalties, if any, as income tax expense on the consolidated statements of operations and other comprehensive income.

 

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

Revenue Recognition

We recognize revenue in accordance with ASC Topic 605, Revenue Recognition, (“ASC Topic 605”). ASC Topic 605 requires that all four of the following basic criteria be met before revenue is realized or realizable and earned: (1) there is persuasive evidence that an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the seller’s price to the buyer is fixed and determinable; and (4) collectability is reasonably assured.

We derive over 95% of our revenues from tenant rents and other tenant-related activities. We lease multi-family units under operating leases with terms of one year or less. Rental income and other property revenues are recorded when due from tenants and recognized monthly as earned pursuant to the terms of the underlying leases. Other property revenues consist primarily of laundry, application and other fees charged to tenants.

We lease commercial space primarily under long-term lease agreements. Commercial tenant rents include base rents, expense reimbursements (such as common area maintenance, real estate taxes and utilities), and straight-line rents. We record base rents on a straight-line basis. The monthly base rent income according to the terms of our leases is adjusted so that an average monthly rent is recorded for each tenant over the term of its lease. The straight-line rent adjustment increased revenue by $56 and $109 for the three months ended June 30, 2014 and 2013, respectively. The straight-line rent adjustment increased revenue by $133 and $226 for the six months ended June 30, 2014 and 2013, respectively. The straight-line receivable balance included in receivables on the consolidated balance sheets as of June 30, 2014 and December 31, 2013 was $2,484 and $2,352, respectively. We receive payments for expense reimbursements from substantially all our multi-tenant commercial tenants throughout the year based on estimates. Differences between estimated recoveries and the final billed amounts, which generally are immaterial, are recognized in the subsequent year.

Earnings per Common Share

Basic earnings per common share is computed by dividing net income available to common shareholders (the “numerator”) by the weighted average number of common shares outstanding (the “denominator”) during the period. Sterling had no dilutive potential common shares as of June 30, 2014 and 2013, and therefore, basic earnings per common share was equal to diluted earnings per common share for both periods.

For the three months ended June 30, 2014 and 2013, Sterling’s denominators for the basic and diluted earnings per common share were approximately 5,443,000 and 5,353,000, respectively. For the six months ended June 30, 2014 and 2013, Sterling’s denominators for the basic and diluted earnings per common share were approximately 5,441,000 and 5,334,000, respectively.

Recent Accounting Pronouncements

In April 2014, the FASB issued ASU No. 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity (“ASU 2014-08”). This newly issued accounting standard amends the definition of a discontinued operation in ASC 205-20 and requires an entity to provide additional disclosures about disposal transactions that do not meet the discontinued-operations criteria. ASU 2014-08 is effective prospectively for all disposals (except disposals classified as held for sale before the adoption date) or components initially classified as held for sale in periods beginning on or after December 15, 2014, with early adoption permitted; and was adopted by the Company effective January 1, 2014. The adoption of this standard did not have a material impact on the Company’s financial position, results of operation or cash flows.

In May 2014, the Financial Accounting Standards Board, or FASB, and International Accounting Standards Board issued their final standard on revenue from contracts with customers, which was issued by the FASB as Accounting Standards Update 2014-09, Revenue from Contracts with Customers, or ASU 2014-09. ASU 2014-09, which establishes a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers, supersedes most current GAAP applicable to revenue recognition and converges U.S. and international accounting standards in this area. The core principle of the new guidance is that revenue shall only be recognized when an entity has transferred control of goods or services to a customer and for an amount reflecting the consideration to which the entity expects to be entitled for such

 

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

exchange. ASU 2014-09 is effective for public entities for annual reporting periods beginning after December 15, 2016, with no early adoption permitted, and allows for full retrospective adoption applied to all periods presented or modified retrospective adoption with the cumulative effect of initially applying the standard recognized at the date of initial application. We have not yet determined the effect ASU 2014-09 will have on our consolidated financial statements.

Reclassifications

Certain amounts previously reported in our quarterly report ended June 30, 2013 have been reclassified to conform to discontinued operations presentations in 2014.

NOTE 3 – SEGMENT REPORTING

We report our results in two reportable segments: residential and commercial properties. Our residential properties include multi-family and assisted senior living properties. Our commercial properties include retail, office, industrial, restaurant and medical properties. We assess and measure operating results based on net operating income (“NOI”), which we define as total real estate segment revenues less real estate expenses (which consist of real estate taxes, property management fees, utilities, repairs and maintenance, insurance and direct administrative costs). We believe NOI is an important measure of operating performance even though it should not be considered an alternative to net income or cash flow from operating activities. NOI is unaffected by financing, depreciation, amortization, legal and professional fees and other general and administrative expenses. The accounting policies of each segment are consistent with those described in Note 2 of this report.

Segment Revenues and Net Operating Income

The revenues and net operating income for the reportable segments (residential and commercial) are summarized as follows for the three and six month periods ended June 30, 2014 and 2013, along with reconciliations to the consolidated financial statements. Segment assets are also reconciled to Total Assets as reported in the consolidated financial statements.

 

Three months ended June 30, 2014

   Residential      Commercial      Total  
     (in thousands)  

Income from rental operations

   $ 12,909       $ 4,353       $ 17,262   

Expenses from rental operations

     6,647         711         7,358   
  

 

 

    

 

 

    

 

 

 

Net operating income

   $ 6,262       $ 3,642         9,904   
  

 

 

    

 

 

    

 

 

 

Interest

           3,082   

Depreciation and amortization

           3,377   

Administration of REIT

           1,310   

Other (income)/expense

           (659
        

 

 

 

Net income

         $ 2,794   
        

 

 

 

 

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

Three months ended June 30, 2013

   Residential      Commercial      Total  
     (in thousands)  

Income from rental operations

   $ 10,221       $ 4,672       $ 14,893   

Expenses from rental operations

     4,591         1,132         5,723   
  

 

 

    

 

 

    

 

 

 

Net operating income

   $ 5,630       $ 3,540         9,170   
  

 

 

    

 

 

    

 

 

 

Interest

           2,661   

Depreciation and amortization

           2,962   

Administration of REIT

           1,270   

Other (income)/expense

           (198
        

 

 

 

Income from continuing operations

  

     2,475   

Discontinued operations

  

     281   
        

 

 

 

Net income

         $ 2,756   
        

 

 

 

Six months ended June 30, 2014

   Residential      Commercial      Total  
     (in thousands)  

Income from rental operations

   $ 25,525       $ 8,821       $ 34,346   

Expenses from rental operations

     13,162         1,525         14,687   
  

 

 

    

 

 

    

 

 

 

Net operating income

   $ 12,363       $ 7,296         19,659   
  

 

 

    

 

 

    

 

 

 

Interest

           6,146   

Depreciation and amortization

           6,732   

Administration of REIT

           2,354   

Other (income)/expense

           (1,232
        

 

 

 

Net income

         $ 5,659   
        

 

 

 

Six months ended June 30, 2013

   Residential      Commercial      Total  
     (in thousands)  

Income from rental operations

   $ 20,150       $ 9,380       $ 29,530   

Expenses from rental operations

     9,050         2,277         11,327   
  

 

 

    

 

 

    

 

 

 

Net operating income

   $ 11,100       $ 7,103         18,203   
  

 

 

    

 

 

    

 

 

 

Interest

           5,354   

Depreciation and amortization

           5,801   

Administration of REIT

           2,767   

Other (income)/expense

           (376
        

 

 

 

Income from continuing operations

  

     4,657   

Discontinued operations

  

     530   
        

 

 

 

Net income

         $ 5,187   
        

 

 

 

 

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

Segment Assets and Accumulated Depreciation

 

As of June 30, 2014

   Residential     Commercial     Total  
     (in thousands)  

Real estate investments

   $ 319,373      $ 152,826      $ 472,199   

Accumulated depreciation

     (34,158     (18,462     (52,620
  

 

 

   

 

 

   

 

 

 
   $ 285,215      $ 134,364        419,579   
  

 

 

   

 

 

   

 

 

 

Cash and cash equivalents

         785   

Restricted deposits and funded reserves

         7,801   

Investment in unconsolidated affiliates

         9,171   

Receivables and other assets

         3,881   

Investment in marketable securities

         7,676   

Financing costs, less accumulated amortization

         2,638   

Intangible assets, less accumulated amortization

         9,868   
      

 

 

 

Total Assets

       $ 461,399   
      

 

 

 

As of December 31, 2013

   Residential     Commercial     Total  
     (in thousands)  

Real estate investments

   $ 296,377      $ 153,873      $ 450,250   

Accumulated depreciation

     (30,075     (16,983     (47,058
  

 

 

   

 

 

   

 

 

 
   $ 266,302      $ 136,890        403,192   
  

 

 

   

 

 

   

 

 

 

Cash and cash equivalents

         13,849   

Restricted deposits and funded reserves

         5,585   

Investment in unconsolidated affiliates

         7,366   

Receivables and other assets

         4,879   

Financing costs, less accumulated amortization

         2,950   

Intangible assets, less accumulated amortization

         10,479   
      

 

 

 

Total Assets

       $ 448,300   
      

 

 

 

NOTE 4 – REAL ESTATE INVESTMENTS

 

As of June 30, 2014    Residential     Commercial     Total  
     (in thousands)  

Land and land improvements

   $ 38,590      $ 28,392      $ 66,982   

Building and improvements

     256,434        122,967        379,401   

Furniture and fixtures

     18,495        1,467        19,962   

Construction in progress

     5,854        —          5,854   
  

 

 

   

 

 

   

 

 

 
     319,373        152,826        472,199   

Less accumulated depreciation

     (34,158     (18,462     (52,620
  

 

 

   

 

 

   

 

 

 
   $ 285,215      $ 134,364      $ 419,579   
  

 

 

   

 

 

   

 

 

 

 

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

As of December 31, 2013    Residential     Commercial     Total  
     (in thousands)  

Land and land improvements

   $ 36,625      $ 28,506      $ 65,131   

Building and improvements

     240,343        123,900        364,243   

Furniture and fixtures

     17,372        1,467        18,839   

Construction in progress

     2,037        —          2,037   
  

 

 

   

 

 

   

 

 

 
     296,377        153,873        450,250   

Less accumulated depreciation

     (30,075     (16,983     (47,058
  

 

 

   

 

 

   

 

 

 
   $ 266,302      $ 136,890      $ 403,192   
  

 

 

   

 

 

   

 

 

 

Construction in progress consists of costs associated with the development of a new, four building 156 unit multi-family apartment community under construction in Bismarck, North Dakota. The project is estimated to cost $16,000 and is expected to be substantially completed in June 2015. The Company is working with GOLDMARK Development Corporation, a related party, as the general contractor for the project. See Note 15 for additional information.

NOTE 5 – HEDGING ACTIVITIES

As part of our interest rate risk management strategy, we use derivative instruments to minimize significant unanticipated earnings fluctuations that may arise from rising variable interest rate costs associated with existing borrowings. To meet these objectives, we have entered into interest rate swaps in the amount of $1,294 and $2,450 to provide a fixed rate of 7.25% and 2.57%, respectively. The swaps mature on April 2020 and December 2017, respectively. The swaps were issued at approximate market terms and thus no fair value adjustment was recorded at inception.

The carrying amount of the swaps have been adjusted to their fair values at the end of the quarter, which because of changes in forecasted levels of LIBOR, resulted in reporting a liability for the fair value of the future net payments forecasted under the swaps. The interest rate swaps are accounted for as effective hedges in accordance with ASC 815-20 whereby they are recorded at fair value and changes in fair value are recorded to comprehensive income. As of June 30, 2014 and December 31, 2013, we have recorded a liability and other comprehensive loss of $307 and $309, respectively.

NOTE 6 – INVESTMENT IN MARKETABLE SECURITIES

Investments in marketable securities consist of real estate backed equity securities. These securities are stated at market value, as determined by the most recently traded price of each security at the balance sheet date. Consistent with the Company’s overall investment objectives and activities, the marketable securities portfolio is classified as trading (as defined by U.S. generally accepted accounting principles). Accordingly all unrealized gains and losses on this portfolio are recorded in income. The following table summarizes the Company’s investment in marketable securities as of June 30, 2014. As of December 31, 2013, the Company held no marketable securities.

 

     June 30, 2014  
     Cost      Fair      Unrealized  
     Basis      Value      Gain (Loss)  
     (in thousands)  

Common stock

   $ 2,026       $ 2,199       $ 173   

Preferred stock

     4,309         4,582         273   

Mutual funds, Exchange-traded funds and other

     817         895         78   
  

 

 

    

 

 

    

 

 

 

Total equity securities

   $ 7,152       $ 7,676       $ 524   
  

 

 

    

 

 

    

 

 

 

 

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

Net gain from investments in marketable securities for the six months ended June 30, 2014 is summarized below:

 

     For the Six  
     Months Ended  
     June 30, 2014  
     (in thousands)  

Net realized (loss) gain from sales of marketable securities

   $ 48   

Net unrealized gain from marketable securities

     524   

Dividend income

     137   
  

 

 

 
   $ 709   
  

 

 

 

NOTE 7 – LEASE INTANGIBLES

The following table summarizes the net value of other intangible assets and liabilities and the accumulated amortization for each class of intangible:

 

     Lease     Accumulated     Lease  
As of June 30, 2014    Intangibles     Amortization     Intangibles, net  
     (in thousands)  

In-place leases

   $ 11,733      $ (3,922   $ 7,811   

Above-market leases

     2,466        (409     2,057   

Below-market leases

     (1,385     504        (881
  

 

 

   

 

 

   

 

 

 
   $ 12,814      $ (3,827   $ 8,987   
  

 

 

   

 

 

   

 

 

 
     Lease     Accumulated     Lease  
As of December 31, 2013    Intangibles     Amortization     Intangibles, net  
     (in thousands)  

In-place leases

   $ 11,733      $ (3,383   $ 8,350   

Above-market leases

     2,466        (337     2,129   

Below-market leases

     (1,385     432        (953
  

 

 

   

 

 

   

 

 

 
   $ 12,814      $ (3,288   $ 9,526   
  

 

 

   

 

 

   

 

 

 

 

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

The estimated aggregate amortization expense for each of the five succeeding fiscal years and thereafter is as follows:

 

Years ending December 31,

   Amount  
     (in thousands)  

2015

   $ 1,076   

2016

     1,076   

2017

     1,076   

2018

     1,076   

2019

     1,076   

Thereafter

     3,607   
  

 

 

 
   $ 8,987   
  

 

 

 

The weighted average amortization period for the intangible assets, in-place leases, above-market leases, and below-market leases acquired as of June 30, 2014 was 11.9 years.

NOTE 8 – LINES OF CREDIT

We have a $15,000 variable rate (1-month LIBOR plus 2.35%) line of credit agreement with Wells Fargo Bank, which expires in July 2015; a $3,000 variable rate (prime rate less 0.5%) line of credit agreement with Bremer Bank, which expires in November 2014; and a $2,660 variable rate (prime rate less 0.25%) line of credit agreement with Bell State Bank & Trust, which expires in April 2015. The lines of credit are secured by properties in Duluth, Minnesota; St. Cloud, Minnesota; Minneapolis/St. Paul, Minnesota, Moorhead, Minnesota and Fargo, North Dakota, respectively. We also have a $1,000 variable rate (the greater of the prime rate or 3.25%) unsecured line of credit agreement with Bremer Bank, which expires October 2014. At June 30, 2014 there was $1,422 outstanding on the lines of credit, leaving $20,238 unused under the agreements. At December 31, 2013, there was no balance outstanding on the lines of credit, leaving $21,000 unused under the agreements. The line of credit agreements include covenants that, in part, impose maintenance of certain debt service coverage and debt to net worth ratios. As of June 30, 2014 and December 31, 2013, we were in compliance with all covenants.

 

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

NOTE 9 – MORTGAGE NOTES PAYABLE

The following table summarizes the Company’s mortgage notes payable. As of June 30, 2014 and December 31, 2013 all are fixed rate notes.

 

          Interest     Principal Balance At  
          Rate Per     June 30,      December 31,  

Maturity Date

  

Property Name

   Annum     2014      2013  
                (in thousands)  

Residential Properties

          

April-2021

   Arbor I      4.48   $ 454       $ —     

April-2021

   Arbor II      4.48     464         —     

April-2021

   Arbor III      4.48     461         —     

October-2017

   Auburn II      6.30     619         625   

July-2016

   Autumn Ridge 3 &4      4.50     3,256         3,318   

January-2016

   Autumn Ridge 1 & 2      5.74     2,837         2,868   

October-2033

   Bayview      4.62     3,526         3,582   

June-2018

   Berkshire      3.75     303         311   

March-2017

   Betty Ann and Martha Alice      3.95     1,186         1,203   

September-2021

   Brookfield      3.75     1,290         1,366   

September-2036

   Carling Manor      4.40     531         538   

November-2024

   Country Club      4.37     597         619   

October-2033

   Courtyard      3.92     4,400         4,475   

October-2019

   Danbury      5.03     2,999         3,037   

October-2028

   Dellwood      4.55     8,056         8,146   

March-2017

   Eagle Run      3.95     4,648         4,713   

June-2018

   Emerald Court      3.75     620         637   

March-2017

   Fairview      3.95     3,220         3,257   

June-2023

   Flickertail      3.75     5,893         5,947   

September-2020

   Forest      4.55     482         492   

December-2017

   Galleria III      4.75     621         630   

August-2016

   Glen Pond      6.30     15,934         16,096   

April-2031

   Griffin Court      4.38     704         —     

April-2021

   Hannifin      4.48     522         —     

October-2017

   Hunter’s Run I      6.30     298         300   

April-2021

   Islander      4.48     947         —     

June-2020

   Kennedy      4.55     526         537   

December-2017

   Library Lane      6.10     1,897         1,915   

May-2021

   Maple Ridge      5.69     4,321         4,353   

October-2028

   Maplewood Bend      4.58     5,519         5,580   

February-2018

   Mayfair      3.63     806         822   

October-2023

   Montreal Courts      4.91     19,832         19,976   

September-2017

   Oak Court      5.98     1,847         1,863   

June-2020

   Pacific Park I      4.55     783         798   

June-2020

   Pacific Park II      4.55     670         683   

June-2020

   Pacific Park South      4.55     413         421   

February-2018

   Parkwood      3.63     1,184         1,208   

December-2023

   Pebble Creek      4.65     4,650         4,700   

June-2018

   Prairiewood Courts      3.75     1,499         1,539   

October-2020

   Prairiewood Meadows      6.17     2,364         2,386   

November-2023

   Richfield/Harrison      4.39     6,415         6,488   

 

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

          Interest     Principal Balance At  
          Rate Per     June 30,      December 31,  

Maturity Date

  

Property Name

   Annum     2014      2013  
                (in thousands)  

September-2017

   Rosegate      5.93     2,353         2,373   

September-2036

   Saddlebrook      4.40     1,093         1,107   

August-2019

   Sierra Ridge Phase I      5.46     2,636         2,668   

November-2019

   Sierra Ridge Phase II      5.92     3,328         3,362   

October-2022

   Somerset      4.01     3,288         3,318   

July-2021

   Southgate      5.96     2,987         3,019   

February-2020

   Southview III      4.50     233         236   

December-2017

   Southview Villages      6.10     2,074         2,094   

June-2020

   Spring      4.55     639         651   

April-2015

   Stonybrook      5.40     5,517         5,574   

January-2022

   Sunset Ridge      4.44     9,066         9,146   

May-2019

   Sunview      4.10     1,214         1,230   

April-2023

   Sunwood Estates      4.37     3,007         3,032   

June-2019

   Terrace on the Green      6.53     2,148         2,163   

October-2022

   Twin Parks      4.01     2,338         2,359   

May-2019

   Village      4.10     1,071         1,085   

July-2016

   Village Park      6.15     869         884   

June-2018

   Westwind      3.75     345         354   

June-2020

   Westwood      4.55     4,949         5,041   

April-2023

   Willow Park      3.59     4,377         4,434   

Commercial Properties

          

September-2017

   Guardian Building Products      3.45     2,274         2,318   

October-2033

   Titan Machinery—Dickinson, ND      4.50     980         996   

December-2019

   Titan Machinery—Fargo, ND      4.18     1,176         1,198   

August-2033

   Titan Machinery—Marshall, MN      4.50     2,267         2,304   

August-2017

   Titan Machinery—Minot, ND      3.29     1,716         1,750   

February-2023

   Titan Machinery—Redwood Falls, MN      4.25     1,724         1,754   

October-2028

   Titan Machinery—Sioux City, IA      4.50     1,695         1,736   

March-2016

   Bio-life Properties—ND, MN, WI (9 total)      7.65     8,177         8,800   

December-2016

   Bio-life Properties—Marquette, MI      7.06     1,168         1,258   

August-2017

   Aetna      5.93     6,881         6,945   

December-2017

   32nd Avenue Office (a)      3.19     2,245         2,272   

March-2019

   Echelon      4.25     1,137         1,161   

April-2018

   Gate City      3.97     1,033         1,050   

September-2020

   Goldmark Office Park      5.33     4,373         4,664   

April-2020

   Great American Building (a)      2.15     1,055         1,072   

October-2015

   Regis      5.68     9,416         9,527   

April-2018

   Dairy Queen—Dickinson, ND      3.63     688         709   

April-2025

   Walgreens-Alexandria      5.69     2,031         2,097   

March-2034

   Walgreens-Batesville      6.85     6,385         6,460   

June-2021

   Walgreens-Colorado      4.50     4,282         4,339   

August-2033

   Walgreens-Fayetteville      6.85     4,901         4,962   

October-2024

   Walgreens-Laurel      6.07     2,010         2,077   
       

 

 

    

 

 

 
        $ 238,740       $ 239,008   
       

 

 

    

 

 

 

 

(a) interest rate per annum is swap rate

 

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

Mortgages are secured by the respective properties, assignment of rents, business assets, deeds to secure debt, deeds of trust and/or cash deposits with lender.

Certain mortgage note agreements include covenants that, in part, impose maintenance of certain debt service coverage and debt to worth ratios. As of June 30, 2014 we were in compliance with all covenants with the exception of one loan on a residential property in Fargo, North Dakota with an outstanding principal balance of $2,338 at June 30, 2014. The property has scheduled deferred maintenance at an estimated cost of $15 to be completed in the fall of 2014. As of June 30, 2014, the uncompleted repairs required under the loan constituted non-compliance. However, subsequent to quarter end, an extension was obtained through December 31, 2014, in which the lender has agreed to forebear any remedies pending the completion of the repairs. As of December 31, 2013, we were in compliance with all covenants.

We are required to make the following principal payments on our outstanding mortgage notes payable for each of the five succeeding fiscal years and thereafter as follows:

 

Years ending December 31,

   Amount  
     (in thousands)  

2014 (July 1, 2014 to December 31, 2014)

   $ 3,988   

2015

     22,780   

2016

     35,027   

2017

     33,133   

2018

     10,760   

2019

     18,791   

Thereafter

     114,261   
  

 

 

 

Total payments

   $ 238,740   
  

 

 

 

NOTE 10 – FAIR VALUE MEASUREMENT

The following table presents the carrying value and estimated fair value of the Company’s financial instruments:

 

     June 30, 2014      December 31, 2013  
     Carrying             Carrying         
     Value      Fair Value      Value      Fair Value  
     (in thousands)  

Financial assets:

           

Investment in marketable securities

   $ 7,676       $ 7,676       $ —         $ —     
     (in thousands)  

Financial liabilities:

  

Mortgage notes payable

   $ 238,740       $ 245,199       $ 239,008       $ 240,486   

Fair value of interest rate swaps

   $ 307       $ 307       $ 309       $ 309   

The carrying values shown in the table are included in the consolidated balance sheets under the indicated captions.

ASC 820-10 established a three-level valuation hierarchy for fair value measurement. Management uses these valuation techniques to establish the fair value of the assets at the measurement date. These valuation techniques are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect management’s assumptions.

 

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

These two types of inputs create the following fair value hierarchy:

 

    Level 1 – Quoted prices for identical instruments in active markets;

 

    Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose significant inputs are observable;

 

    Level 3 – Instruments whose significant inputs are unobservable.

The guidance requires the use of observable market data, when available, in making fair value measurements. When inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement.

Recurring Fair Value Measurements

The following table presents the Company’s financial instruments, which are measured at fair value on a recurring basis, by the level in the fair value hierarchy within which those measurements fall. Methods and assumptions used to estimate the fair value of these instruments are described after the table.

 

     Level 1      Level 2      Level 3      Total  
     (in thousands)  

June 30, 2014

           

Fair value of interest rate swaps

   $ —         $ 307       $ —         $ 307   

Investment in marketable securities

     7,676         —           —           7,676   

December 31, 2013

           

Fair value of interest rate swaps

   $ —         $ 309       $ —         $ 309   

Investment in marketable securities: The fair value of the marketable equity securities is determined using quoted market prices at the reporting date multiplied by the quantity held.

Fair value of interest rate swaps: The fair value of interest rate swaps is determined using a discounted cash flow analysis on the expected future cash flows of the derivative. This analysis utilizes observable market data including forward yield curves and implied volatilities to determine the market’s expectation of the future cash flows of the variable component. The fixed and variable components of the derivative are then discounted using calculated discount factors developed based on the LIBOR swap rate and are aggregated to arrive at a single valuation for the period. The Company also incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements.

Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of June 30, 2014 and December 31, 2013, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation. As a result, the Company has determined that its derivative valuations in their entirety are classified within Level 2 of the fair value hierarchy. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered any applicable credit enhancements. The Company’s derivative instruments are further described in Note 5.

 

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except per share data)

 

Fair Value Disclosures

The following table presents the Company’s financial assets and liabilities, which are measured at fair value for disclosure purposes, by the level in the fair value hierarchy within which they fall. Methods and assumptions used to estimate the fair value of these instruments are described after the table.

 

     Level 1      Level 2      Level 3      Total  
     (in thousands)  

June 30, 2014

           

Mortgage notes payable

   $ —         $ —         $ 245,199       $ 245,199   
December 31, 2013            

Mortgage notes payable

   $ —         $ —         $ 240,486       $ 240,486   

Mortgage notes payable: The Company estimates the fair value of its mortgage notes payable by discounting the future cash flows of each instrument at rates currently offered to the Company for similar debt instruments of comparable maturities by the Company’s lenders. Judgment is used in determining the appropriate rate for each of the Company’s individual mortgages and notes payable based upon the specific terms of the agreement, including the term to maturity, the quality and nature of the underlying property and its leverage ratio. The rates used range from 3.95% to 4.53% and from 4.50% to 4.65% at June 30, 2014 and December 31, 2013, respectively. The fair value of the Company’s matured mortgage notes payable were determined to be equal to the carrying value of the properties because there is no market for similar debt instruments and the properties’ carrying value was determined to be the best estimate of fair value as of June 30, 2014. The Company’s mortgage notes payable are further described in Note 9.

NOTE 11 – NONCONTROLLING INTEREST OF UNITHOLDERS IN OPERATING PARTNERSHIP

As of June 30, 2014 and December 31, 2013, outstanding limited partnership units totaled 14,504,000 and 13,547,000 respectively. As of June 30, 2014 and 2013, the operating partnership declared distributions of $3,263 and $2,586 respectively, to limited partners paid in July 2014 and 2013. Distributions per unit were $0.4500 and $0.4200 during the first six months of 2014 and 2013, respectively.

During the first six months of 2014, Sterling exchanged 2,000 common shares for 2,000 limited partnership units held by limited partners, pursuant to redemption requests. The aggregate value of these transactions was $23. During the first six months of 2013 there were no limited partnership units exchanged for Sterling common shares pursuant to redemption requests.

At the sole and absolute discretion of the limited partnership, and so long as a Redemption Plan exists, Limited Partners may request the operating partnership redeem their limited partnership units. The operating partnership may choose to offer the Limited Partner (i) cash for the redemption or, at the request of the Limited Partner, (2) offer shares in lieu of cash for the redemption on a basis of one limited partnership unit for one Sterling common share (the “Exchange Request”). The Exchange Request shall be exercised pursuant to a Notice of Exchange. If the issuance of Sterling common shares pursuant to an Exchange Request will cause the shareholder to exceed the ownership limitations, payment will be made to the Limited Partner in cash. No Limited Partner may exercise an Exchange Request more than twice during any calendar year, and Exchange Requests may not be made for less than 1,000 limited partnership units. If a Limited Partner owns less than 1,000 limited partnership units, all of the limited partnership units held by the Limited Partner must be exchanged pursuant to the Exchange Request.

 

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

NOTE 12 – REDEMPTION PLANS

On March 11, 2011, our Board of Trustees approved redemption plans that enable our shareholders to sell their common shares and the partners of our operating partnership to sell their limited partnership units to us, after they have held the securities for at least one year and subject to other conditions and limitations described in the plans. Originally, the maximum amount of aggregate securities that could be redeemed under these plans was $5,000, and the redemption price was fixed at $12.60 per share or unit under the plans.

On September 7, 2012 and December 20, 2012, our Board of Trustees amended and restated our redemption plans to increase the maximum amount that can be redeemed under the plans to $15,000 worth of securities and increased the fixed redemption price to $12.75 per share or unit under the plans.

On March 28, 2013, our Board of Trustees amended our redemption plans to increase the maximum amount that can be redeemed under the plan to $20,000 worth of securities and increased the fixed redemption price to $13.00 per share or unit under the plans effective May 16, 2013.

On September 26, 2013, our Board of Trustees amended our redemption plans to increase the maximum amount that can be redeemed under the plan to $25,000 worth of securities and increased the fixed redemption price to $14.00 per share or unit under the plans effective October 16, 2013.

On March 27, 2014, our Board of Trustees amended our redemption plans to increase the maximum amount that can be redeemed under the plan to $30,000 worth of securities under the plans effective March 28, 2014.

We may redeem securities under the plans provided the aggregate total has not been exceeded if we have sufficient funds to do so. The plans will terminate in the event the shares become listed on any national securities exchange, the subject of bona fide quotes on any inter-dealer quotation system or electronic communications network or are the subject of bona fide quotes in the pink sheets. Additionally, the Board, in its sole discretion, may terminate, amend or suspend the redemption plans, either or both of them, if it determines to do so in its sole discretion.

During the first six months of 2014 and 2013, the Company redeemed 203,000 and 94,000 common shares valued at $2,836 and $1,198, respectively. In addition, during the first six months of 2014 and 2013, the Company redeemed 70,000 and 72,000 units valued at $976 and $928, respectively.

NOTE 13 – BENEFICIAL INTEREST

We are authorized to issue 100,000,000 common shares of beneficial interest with $0.01 par value and 50,000,000 preferred shares with $0.01 par value, which collectively represent the beneficial interest of Sterling. As of June 30, 2014 and December 31, 2013, there were 5,423,000 and 5,454,000 common shares outstanding. We had no preferred shares outstanding as of either date.

Dividends paid to holders of common shares were $0.4500 per share and $0.4200 per share for the six months ending June 30, 2014 and 2013, respectively.

During the three months ended June 30, 2014, the Company acquired the remaining ownership interest in the Eagle Run property located in West Fargo, North Dakota. Prior to the merger, the operating partnership was an 81.25% owner in the single asset limited liability partnership. The change in ownership interest has been accounted for as an equity transaction, and no gain or loss has been recognized in consolidated net income or comprehensive income. The following schedule discloses the effects of changes in Sterling’s ownership interest in the subsidiary on Sterling’s equity.

 

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

Net income attributable to Sterling and transfers (to) from the noncontrolling interest:

 

     Three Months Ended      Six Months Ended  
     June 30,      June 30,  
     2014     2013      2014     2013  
     (in thousands)      (in thousands)  

Net income attributable to Sterling shareholders

   $ 777      $ 834       $ 1,574      $ 1,581   

Transfers to the noncontrolling interest

         

Decrease in Sterling’s paid-in capital for purchase of remaining interest in Eagle Run Partnership

     (791     —           (791     —     
  

 

 

   

 

 

    

 

 

   

 

 

 

Change from net income attributable to Sterling shareholders and transfers to noncontrolling interest

   $ (14   $ 834       $ 783      $ 1,581   
  

 

 

   

 

 

    

 

 

   

 

 

 

NOTE 14 – DIVIDEND REINVESTMENT PLAN

Our Board of Trustees approved a dividend reinvestment plan to provide existing holders of our common shares with a convenient method to purchase additional common shares without payment of brokerage commissions, fees or service charges. On July 20, 2012, we registered with the Securities Exchange Commission 2,000,000 common shares to be issued under the plan on Form S-3D, which automatically became effective on July 20, 2012.

Under this plan, eligible shareholders may elect to have all or a portion (but not less than 25%) of the cash dividends they receive automatically reinvested in our common shares. If an eligible shareholder elects to reinvest cash dividends under the plan, the shareholder may also make additional optional cash purchases of our common shares, not to exceed five thousand dollars per fiscal quarter without our prior approval. The purchase prices per common share under the plan equals 95% of the estimated value per common share for dividend reinvestments and equals 100% of the estimated value per common share for additional optional cash purchases, as determined by our Board of Trustees. The estimated value per common share was $15.00 and $14.00 at June 30, 2014 and December 31, 2013, respectively. See discussion of determination of estimated value in Note 20.

Therefore, the purchase price per common share for dividend reinvestments was $14.25 and $13.30 and for additional optional cash purchases was $15.00 and $14.00 at June 30, 2014 and December 31, 2013, respectively. The Board, in its sole discretion, may amend, suspend or terminate the plan at any time, without the consent of shareholders, upon a ten day notice to participants.

In the six months ended June 30, 2014, 114,000 shares were issued pursuant to dividend reinvestments and 56,000 shares were issued pursuant to additional optional cash purchases under the plan. In the six months ended June 30, 2013, 102,000 shares were issued pursuant to dividend reinvestments and 29,000 shares were issued pursuant to additional optional cash purchases under the plan.

NOTE 15 – RELATED PARTY TRANSACTIONS

Property Management Fee

During the first six months of 2014 and 2013, we paid property management fees to GOLDMARK Property Management in an amount equal to 5% of rents of the properties managed. GOLDMARK Property Management is owned in part by Kenneth Regan and James Wieland. For the six months ended June 30, 2014 and 2013, we paid management fees of $3,131 and $2,393, respectively, to GOLDMARK Property Management.

 

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

Board of Trustee Fees

We incurred Trustee fees of $24 and $22 during the six months ended June 30, 2014 and 2013, respectively. As of June 30, 2014, we owed our Trustees $24 for unpaid board of trustee fees. There were no board of trustee fees owed to our Trustees as of December 31, 2013. There is no cash retainer paid to Trustees. Instead, we pay Trustees specific amounts for meetings attended. In March 2014, our Board revised the Trustee Compensation Plan effective January 1, 2014. The plan provides:

 

     2014      2013 (1)  

Board Chairman – Board Meeting

     105 shares/meeting       $ 1,400/meeting   

Trustee – Board Meeting

     75 shares/meeting       $ 1,000/meeting   

Committee Chair – Committee Meeting

     30 shares/meeting       $ 400/meeting   

Trustee – Committee Meeting

     30 shares/meeting       $ 400/meeting   

 

(1) The amounts in the table are actual amounts paid, not rounded.

Common shares earned in accordance with the plan are calculated on an annual basis. Shares earned pursuant to the Trustee Compensation Plan are issued on or about July 15 for Trustees’ prior year of service. Non-independent Trustees will not be compensated for their service on the Board or Committees.

Advisory Agreement

We are an externally managed trust and as such, although we have a Board of Trustees and executive officers responsible for our management, we have no paid employees. The following is a brief description of the current fees and compensation that may be received by the Advisor under the Advisory Agreement, which must be renewed on an annual basis and approved by a majority of the independent trustees. The Advisory Agreement was approved by the Board of Trustees (including all the independent Trustees) on March 27, 2014, effective January 1, 2014.

Management Fee: 0.35% of our total assets (before depreciation and amortization), annually. Total assets are our gross assets (before depreciation and amortization) as reflected on our consolidated financial statements, taken as of the end of the fiscal quarter last preceding the date of computation. The management fee will be payable monthly in cash or our common shares, at the option of the Advisor, not to exceed one-twelfth of 0.35% of the total assets as of the last day of the immediately preceding month. The management fee calculation is subject to quarterly and annual reconciliations. The management fee may be deferred at the option of the Advisor, without interest.

Acquisition Fee: For its services in investigating and negotiating acquisitions of investments for us, the Advisor receives an acquisition fee of 2.5% of the purchase price of each property acquired, capped at $375 per acquisition. The total of all acquisition fees and acquisition expenses cannot exceed 6% of the purchase price of the investment, unless approved by a majority of the trustees, including a majority of the independent trustees, if they determine the transaction to be commercially competitive, fair and reasonable to us.

Disposition Fee: For its services in the effort to sell any investment for us, the Advisor receives a disposition fee of 2.5% of the sales price of each property disposition, capped at $375 per disposition.

Financing Fee: 0.25% of all amounts made available to us pursuant to any loan, refinance (excluding rate and/or term modifications of an existing loan with the same lender), line of credit or other credit facility.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

Development Fee: Based on regressive sliding scale (starting at 5% and declining to 3%) of total project costs, excluding cost of land, for development services requested by us.

 

Total Cost

   Fee     Range of Fee    Formula

0 – 10M

     5.0   0 – .5M    0M – 5.0% x (TC – 0M)

10M – 20M

     4.5   .5M – .95M    .50M – 4.5% x (TC – 10M)

20M – 30M

     4.0   .95M – 1.35M    .95M – 4.0% x (TC – 20M)

30M – 40M

     3.5   1.35M – 1.70M    1.35M – 3.5% x (TC – 30M)

40M – 50M

     3.0   1.70M – 2.00M    1.70M – 3.0% x (TC – 40M)

TC = Total Project Cost

Management Fees

During the first six months of 2014 and 2013, we incurred advisory management fees of $891 and $701 with Sterling Management, LLC, our Advisor, for advisory management fees. As of June 30, 2014 and December 31, 2013, we owed our Advisor $152 and $294, respectively, for unpaid advisory management fees. These fees cover the office facilities, equipment, supplies, and staff required to manage our day-to-day operations.

Acquisition Fees

During the first six months of 2014 and 2013, we incurred acquisition fees of $432 and $809, respectively, with our Advisor. These fees are for performing due diligence on properties acquired. As of June 30, 2014, we owed our Advisor $292 for unpaid acquisition fees. There were no acquisition fees owed to our Advisor as of December 31, 2013.

Financing Fees

During the first six months of 2014 and 2013, we incurred financing fees of $11 and $48 with our Advisor for loan financing and refinancing activities, respectively. As of June 30, 2014, we owed our Advisor $2 for unpaid financing fees. There were no financing fees owed to our Advisor as of December 31, 2013.

Disposition Fees

During the first six months of 2014, there were no disposition fees incurred with our Advisor. During the first six months of 2013, we incurred $8 in disposition fees with our Advisor. See Note 19. There were no disposition fees owed to our Advisor as of June 30, 2014 and December 31, 2013, respectively.

Development Fees

We did not incur any development fees during the first six months of 2014 and 2013.

Commissions

During the first six months of 2014 and 2013, we incurred brokerage fees of $0 and $67, respectively, to a broker-dealer benefitting Larry O’Callaghan, a member of the Board of Trustees until June 2013. Brokerage fees were based on 8% of the purchase price of Sterling common shares sold and 4% of the purchase price of UPREIT units sold. As of June 30, 2014 and December 31, 2013, there were no outstanding brokerage fees owed to the broker-dealer.

During the first six months of 2014 and 2013, we incurred real estate commissions of $535 and $706, respectively, owed to GOLDMARK SCHLOSSMAN Commercial Real Estate Services, Inc., which is controlled by Messrs. Regan and Wieland. There were no outstanding commissions owed as of June 30, 2014 and December 31, 2013.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

Rental Income

During the first six months of 2014 and 2013, we received rental income of $90 and $90, respectively, under an operating lease agreement with GOLDMARK Property Management.

During the first six months of 2014 and 2013, we received rental income of $25 and $20, respectively, under an operating lease agreement with GOLDMARK SCHLOSSMAN Commercial Real Estate Services, Inc.

During the first six months of 2014 and 2013, we received rental income of $21 and $21, respectively, under operating lease agreements with our Advisor.

Construction Costs

During the first six months of 2014 and 2013, we incurred costs related to the construction of a 156 unit apartment complex in Bismarck, North Dakota of $5,851 and $322 to GOLDMARK Development, respectively. As of June 30, 2014 and December 31, 2013, we owed GOLDMARK Development $292 and $102, respectively, for retainage. In addition as of June 30, 2014 and December 31, 2013 we owed GOLDMARK Development $1,092 and $365, respectively, for unpaid construction fees.

NOTE 16 – RENTALS UNDER OPERATING LEASES / RENTAL INCOME

Residential apartment units are rented to individual tenants with lease terms of one year or less. Gross revenues from residential rentals totaled $25,525 and $20,150 for the six months ended June 30, 2014 and 2013, respectively.

Commercial properties are leased to tenants under terms expiring at various dates through 2034. Lease terms often include renewal options. For the six months ended June 30, 2014 and 2013, gross revenues from commercial property rentals, including CAM income (common area maintenance) of $1,088 and $1,852, respectively, totaled $8,821 and $9,380, respectively.

NOTE 17 – PROPERTY MANAGEMENT FEES

We have entered into various property management agreements with unrelated management companies. The agreements provide for the payment of property management fees based on a percentage of rental income. During the six months ended June 30, 2014 and 2013, we incurred property management fees of $37 and $42, respectively, to unrelated management companies.

During the six month periods ended June 30, 2014 and 2013, we paid property management fees of $3,131 and $2,393, respectively, to GOLDMARK Property Management, a related party. The Company’s related party property management fees are further described in Note 15.

NOTE 18 – COMMITMENTS AND CONTINGENCIES

Environmental Matters

Federal law (and the laws of some states in which we own or may acquire properties) imposes liability on a landowner for the presence on the premises of hazardous substances or wastes (as defined by present and future federal and state laws and regulations). This liability is without regard to fault or knowledge of the presence of such substances and may be imposed jointly and severally upon all succeeding landowners. If such hazardous substance is discovered on a property acquired by us, we could incur liability for the removal of the substances and the cleanup of the property.

There can be no assurance that we would have effective remedies against prior owners of the property. In addition, we may be liable to tenants and may find it difficult or impossible to sell the property either prior to or following such a cleanup.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

Risk of Uninsured Property Losses

We maintain property damage, fire loss, and liability insurance. However, there are certain types of losses (generally of a catastrophic nature) which may be either uninsurable or not economically insurable. Such excluded risks may include war, earthquakes, tornados, certain environmental hazards, and floods. Should such events occur, (i) we might suffer a loss of capital invested, (ii) tenants may suffer losses and may be unable to pay rent for the spaces, and (iii) we may suffer a loss of profits which might be anticipated from one or more properties.

Litigation

The Company is subject, from time to time, to various legal proceedings and claims that arise in the ordinary course of business. While the resolution of such matters cannot be predicted with certainty, management believes, based on currently available information, that the final outcome of such matters will not have a material effect on the financial statements of the Company.

NOTE 19 – DISCONTINUED OPERATIONS

Effective January 1, 2014, we prospectively adopted ASU 2014-08 for properties not previously sold or classified as held for sale. The standard did not have a material impact on our consolidated statements of operations and other comprehensive income for the six months ended June 30, 2014 because we did not sell any properties during such period. Prior to the prospective adoption of ASU 2014-08, Accounting Standards Code, or ASC, Topic 360, Property, Plant and Equipment, required, among other things, that in a period in which a component of an entity either has been disposed of or is classified as held for sale, the statements of operations for the current and prior periods shall report the results of operations of the component as discontinued operations. Consequently, the net operating results of those properties sold or classified as held for sale prior to January 1, 2014 are accounted for as discontinued operations for all periods presented. This presentation does not have an impact on net income attributable to common shareholders, it only results in the reclassification of operating results within the consolidated statements of operations and other comprehensive income for the six months ended June 30, 2013.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

As previously disclosed in our 2013 Annual Report on Form 10-K, the operating partnership sold one senior living property and one parcel of vacant land for approximately $24,000 and $276, respectively. The operations of these properties as well as the gain on sale have been presented as income from discontinued operations in the accompanying consolidated statements of operations and other comprehensive income. Accordingly, certain reclassifications have been made to prior years to reflect discontinued operations consistent with current year presentation. The following is a summary of income from discontinued operations for the period presented (in thousands):

 

    

Discontinued Operations

Three Months Ended
June 30,

     Discontinued Operations
Six Months Ended
June 30,
 
     2014      2013      2014      2013  
     (in thousands)      (in thousands)  

Income from rental operations

     

Real estate rental income

   $ —         $ 540       $ —         $ 1,080   

Tenant reimbursements

     —           68         —           136   
  

 

 

    

 

 

    

 

 

    

 

 

 
     —           608         —           1,216   

Expenses

           

Expenses from rental operations

           

Interest

     —           94         —           202   

Depreciation and amortization

     —           181         —           361   

Real estate taxes

     —           69         —           140   
  

 

 

    

 

 

    

 

 

    

 

 

 
     —           344         —           703   

Administration of REIT

           

Acquisition and disposition expenses

     —           25         —           25   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total expenses

     —           369         —           728   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income from discontinued operations before gain on sale

     —           239         —           488   

Gain on sale of discontinued operations

     —           42         —           42   
  

 

 

    

 

 

    

 

 

    

 

 

 

Gain from discontinued operations

   $ —         $ 281       $ —         $ 530   
  

 

 

    

 

 

    

 

 

    

 

 

 

NOTE 20 – BUSINESS COMBINATIONS AND ACQUSITIONS

We continue to implement our strategy of acquiring properties in desired markets.

We account for our property acquisitions by allocating the purchase price of a property to the property’s assets based on management’s estimates of fair value. Techniques used to estimate fair value include an appraisal of the property by a certified independent appraiser at the time of acquisition. Significant factors included in the independent appraisal include items such as current rent schedules, occupancy levels, and discount factors. Property valuations are completed primarily using the income capitalization approach, which anticipated benefits are converted to an indication of current value.

The total value allocable to intangible assets acquired, which consists of unamortized lease origination costs, in-place leases and tenant relationships, are allocated based on management’s evaluation of the specific characteristics of each tenant’s lease, our overall relationship with that respective tenant, growth prospects for developing new business with the tenant, the remaining term of the lease and the tenant’s credit quality, among other factors.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

The value allocable to the above or below market component of an acquired in-place lease is determined based upon the present value (using a market discount rate) of the difference between (i) the contractual rents to be paid pursuant to the lease over its remaining term, and (ii) management’s estimate of rents that would be paid using fair market rates over the remaining term of the lease. The amounts allocated to above or below market leases are included in lease intangibles, net in the accompanying balance sheets and are amortized on a straight-line basis as an increase or reduction of rental income over the remaining non-cancelable term of the respective leases.

We estimate the in-place lease value for each lease acquired. This fair value estimate is calculated using factors available in third party appraisals or cash flow estimates of the property prepared by our internal analysis. These estimates are based upon cash flow projections for the property, existing leases, and the current economic climate.

Our analysis results in three discrete financial items: assets for above market leases, liabilities for below market leases, and assets for the in-place lease value. The calculation of each of these components is performed in tandem to provide a complete intangible asset value.

Key factors considered in the calculation of fair value of both real property and intangible assets include the current market rent values, “dark” periods (building in vacant status), direct costs estimated with obtaining a new tenant, discount rates, escalation factors, standard lease terms, and tenant improvement costs.

Purchases during the first six months of 2014

In January 2014, the operating partnership purchased a 24 unit apartment complex in Grand Forks, North Dakota for approximately $1,320. The purchase was financed with the issuance of limited partnership units valued at approximately $1,320.

In January 2014, the operating partnership purchased a 64 unit apartment complex in Fargo, North Dakota for approximately $3,520. The purchase was financed with the issuance of limited partnership units valued at approximately $1,848 and cash. The interest was purchased from an entity affiliated with Mr. Wieland, a related party, who received limited partnership units valued at approximately $739.

In January 2014, the operating partnership purchased a 30 unit apartment complex in Hutchinson, Minnesota for approximately $1,080. The purchase was financed with the issuance of limited partnership units valued at $1,080. The property was purchased from entities affiliated with Messrs. Regan, Wieland and Furness, related parties, who received limited partnership units valued at approximately $216, $216 and $108, respectively.

In January 2014, the operating partnership purchased a 24 unit apartment complex in Crookston, Minnesota for approximately $1,104. The purchase was financed with the issuance of limited partnership units valued at $1,104. The property was purchased from entities affiliated with Messrs. Regan, Wieland and Furness, related parties, who received limited partnership units valued at approximately $221, $221 and $110, respectively.

In May 2014, the operating partnership entered into an agreement to merge the Eagle Run Partnership, LLP into the partnership for approximately $1,566. Following the transaction, Eagle Run Partnership, LLP ceased to exist. The merger was financed with the issuance of limited partnership units valued at $690 and through assumption of mortgage debt of approximately $876. The interest was acquired from an entity affiliated with Messrs. Regan and Wieland, related parties, who received limited partnership units valued at approximately $221, and $110, respectively.

In June 2014, the operating partnership purchased a 128 unit apartment complex in Moorhead, Minnesota for approximately $4,848. The purchase was financed with the combination of an assumed loan of $704 and the issuance of limited partnership units valued at approximately $3,906 and cash. The interest was purchased from an entity affiliated with Messrs. Regan and Wieland, related parties, who received limited partnership units valued at approximately $1,730 and $905, respectively.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

In June 2014, the operating partnership purchased a 142 unit apartment complex in West Fargo, North Dakota for approximately $6,840. The purchase was financed with the combination of the issuance of limited partnership units valued at approximately $4,448 and cash. The interest was purchased from an entity affiliated with Mr. Wieland, a related party, who received limited partnership units valued at approximately $2,738.

The following table summarizes the fair value of the assets acquired and liabilities assumed during the six months ended June 30, 2014:

 

     Property and
Equipment
     In Place
Leases
     Favorable
Lease Terms
     Unfavorable
Lease Terms
     Mortgages
Assumed
    Consideration
Given
 
     (in thousands)  

Barrett Arms Apartments, Crookston, MN

   $ 1,104       $ —         $ —         $ —         $ —        $ 1,104   

Chandler 1802, Grand Forks, ND

     1,320         —           —           —           —          1,320   

Echo Manor Apartments, Hutchinson, MN

     1,080         —           —           —           —          1,080   

Westcourt Apartments, Fargo, ND

     3,520         —           —           —           —          3,520   

Eagle Run Apartments, West Fargo, ND (1)

     1,566         —           —           —           (876     690   

Griffin Court Apartments, Moorhead, MN

     4,848         —           —           —           (704     4,144   

Parkwest Gardens Apartments, West Fargo, ND

     6,840         —           —           —           —          6,840   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 
   $ 20,278       $ —         $ —         $ —         $ (1,580   $ 18,698   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

(1) Assumed loan presented as consideration given, however, previously consolidated the single asset LLP due to controlling financial interest.

Total consideration given for acquisitions through June 30, 2014 was completed through issuing approximately 1,028,000 limited partnership units of the operating partnership valued at $14.00 per unit for an aggregate consideration of approximately $14,396, assumed loans of $1,580, assumed liabilities and deferred maintenance of $167 and cash of $4,135. Units issued in exchange for property are determined through a value established annually by our Board of Trustees, and reflects the fair value at the time of issuance.

Purchases during the first six months of 2013

In January 2013, the operating partnership purchased a 38,932 square foot implement dealership in Redwood Falls, Minnesota for approximately $4,658. The purchase was financed with a combination of a $1,800 loan, the issuance of limited partnership units valued at approximately $2,633 and cash.

In February 2013, the operating partnership purchased a 42 unit apartment complex in Fargo, North Dakota for approximately $2,310. The purchase was financed with the issuance of limited partnership units valued at approximately $2,310. The property was purchased from entities affiliated with Messrs. Regan and Wieland, related parties, who each received limited partnership units valued at approximately $499.

In February 2013, the operating partnership purchased a 20 unit apartment complex in Fargo, North Dakota for approximately $740. The purchase was financed with the issuance of limited partnership units valued at approximately $740. The property was purchased from an entity affiliated with Mr. Regan, a related party, who received limited partnership units valued at approximately $129.

In February 2013, the operating partnership purchased a 12 unit apartment complex in Fargo, North Dakota for approximately $714. The purchase was financed with the combination of a $263 loan and the issuance of limited partnership units valued at approximately $471. The property was purchased from entities affiliated with Messrs. Regan and Wieland, related parties, who each received limited partnership units valued at approximately $100.

In February 2013, the operating partnership purchased a 30 unit apartment complex in Fargo, North Dakota for approximately $957. The purchase was financed with the combination of a $238 loan and the issuance of limited partnership units valued at approximately $751. The property was purchased from entities affiliated with Messrs. Regan and Wieland, related parties, who each received limited partnership units valued at approximately $229.

 

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STERLING REAL ESTATE TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

In February 2013, the operating partnership purchased a 39 unit apartment complex in Fargo, North Dakota for approximately $1,036. The purchase was financed with the issuance of limited partnership units valued at approximately $985 and cash. The property was purchased from entities affiliated with Messrs. Regan and Wieland, related parties, who received cash of $51 and limited partnership units valued at approximately $389, respectively.

In February 2013, the operating partnership purchased a 15 unit apartment complex in Fargo, North Dakota for approximately $550. The purchase was financed with the issuance of limited partnership units valued at approximately $481 and cash. The property was purchased from an entity affiliated with Mr. Regan, a related party, who received cash of $69 and limited partnership units valued at approximately $110.

In February 2013, the operating partnership purchased a 25 unit apartment complex in Fargo, North Dakota for approximately $950. The purchase was financed with the combination of a $210 loan and the issuance of limited partnership units valued at approximately $772. The property was purchased from an entity affiliated with Mr. Regan, a related party, who received cash of $43 and limited partnership units valued at approximately $236.

In February 2013, the operating partnership purchased a 96 unit apartment complex in Grand Forks, North Dakota for approximately $4,416. The purchase was financed with the issuance of limited partnership units valued at approximately $4,416. The property was purchased from entities affiliated with Messrs. Regan and Wieland, related parties, who each received limited partnership units valued at approximately $828.

In May 2013, the operating partnership purchased a 132 unit apartment complex in Anoka, Minnesota for approximately $11,500. The purchase was financed with the issuance of limited partnership units valued at approximately $299 and cash.

In June 2013, the operating partnership purchased an 18 unit apartment complex in Fargo, North Dakota for approximately $756. The purchase was financed with the issuance of limited partnership units valued at approximately $678 and cash. The property was purchased from an entity affiliated with Mr. Regan, a related party, who received limited partnership units valued at approximately $151.

In June 2013, the operating partnership purchased a 12 unit apartment complex in Bismarck, North Dakota for approximately $636. The purchase was financed with the issuance of limited partnership units valued at approximately $636. The property was purchased from an entity affiliated with Mr. Regan, a related party, who received limited partnership units valued at approximately $159.

In June 2013, the operating partnership purchased a 59 unit apartment complex in Fargo, North Dakota for approximately $3,127. The purchase was financed with the issuance of limited partnership units valued at approximately $2,383 and cash. The property was purchased from entities affiliated with Messrs. Regan and Wieland, related parties, who received limited partnership units valued at approximately $691 and $627, respectively.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

The following table summarizes the fair value of the assets acquired and liabilities assumed during the six months ended June 30, 2013:

 

     Property and      In Place      Favorable      Unfavorable      Mortgages      Consideration  
     Equipment      Leases      Lease Terms      Lease Terms      Assumed      Given  
     (in thousands)  

Titan Machinery, Redwood Falls, MN

   $ 3,902       $ 745       $ 11       $ —         $ —         $ 4,658   

44th Street, Fargo, ND

     2,310         —           —           —           —           2,310   

Forest Avenue, Fargo, ND

     740         —           —           —           —           740   

Kennedy, Fargo, ND

     714         —           —           —           —           714   

Pacific Park I, Fargo, ND

     957         —           —           —           —           957   

Pacific Park II, Fargo, ND

     1,036         —           —           —           —           1,036   

Pacific Park South, Fargo, ND

     550         —           —           —           —           550   

Spring, Fargo, ND

     950         —           —           —           —           950   

Stanford Court, Grand Forks, ND

     4,416         —           —           —           —           4,416   

Dellwood Estates, Anoka, MN

     11,500         —           —           —           —           11,500   

Arbor Apartments, Bismarck, ND

     636         —           —           —           —           636   

Granger Court I, Fargo, ND

     3,127         —           —           —           —           3,127   

Schrock Apartments, Fargo, ND

     756         —           —           —           —           756   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 31,594       $ 745       $ 11       $ —         $ —         $ 32,350   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total consideration given for acquisitions through June 30, 2013 was completed through issuing approximately 1,254,000 limited partnership units of the operating partnership valued at $14.00 per unit for an aggregate consideration of approximately $17,555, and cash of $14,795. Units issued in exchange for property are determined through a value established annually by our Board of Trustees, and reflects the fair value at the time of issuance.

Estimated Value of Units/Shares

The Board of Trustees has determined an estimate of fair value for the trust shares issued in the first six months of 2014 and 2013. In addition, the Board of Trustees, acting as general partner for the operating partnership, has determined an estimate of fair value for the limited partnership units issued in the first six months of 2014 and 2013. In determining this value, the board relied upon their experience with, and knowledge about, our real estate portfolio and debt obligations. The board also relied on valuation methodologies that are commonly used in the real estate industry. The methodology used by our board to determine this value was based on the value of our real estate investments, cash and other assets and debt and other liabilities as of a date certain.

Based on the results of the methodologies, the Board determined the fair value of the shares and limited partnership units to be $14.00 per shares/unit for the first three months of 2014 through March 27, 2014 and the first six months of 2013. The Board determined the fair value of the shares and limited partnership units to be $15.00 per share/unit effective March 28, 2014.

As with any valuation methodology, the methodologies utilized by the Board in reaching an estimate of the value of the shares and limited partnership units are based upon a number of estimates, assumptions, judgments or opinions that may, or may not, prove to be correct. The use of different estimates, assumptions, judgments, or opinions would likely have resulted in significantly different estimates of the value of the shares and limited partnership units. In addition, the Board’s estimate of share and limited partnership unit value is not based on the fair values of our real estate, as determined by GAAP, as our book value for most real estate is based on the amortized cost of the property, subject to certain adjustments.

Furthermore, in reaching an estimate of the value of the shares and limited partnership units, the Board did not include a liquidity discount in order to reflect the fact that the shares and limited partnership units are not currently traded on a national securities exchange; a discount for debt that may include a prepayment obligation or a provision precluding assumption of the debt by a third party; or the costs that are likely to be incurred in connection with an appropriate exit strategy, whether that strategy might be a listing of the limited partnership units or Sterling common shares on a national securities exchange or a merger or sale of our portfolio.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014 AND 2013 (UNAUDITED)

(Dollar amounts in thousands, except share and per share data)

 

NOTE 21 – SUBSEQUENT EVENTS

On July 15, 2014, we paid a dividend or distribution of $0.2250 per share on our common shares of beneficial interest, to common shareholders and limited unit holders of record on June 30, 2014.

In August 2014, the operating partnership purchased a 54 unit apartment complex in Fargo, North Dakota for approximately $2,646. The purchase price was financed with the issuance of limited partnership units and cash.

In August 2014, the operating partnership sold a retail property located in Norfolk, Nebraska for an approximate sales price was $625. As of June 30, 2014, the property was not classified as held for sale in accordance with ASC 360, as all the criteria had not been met.

Pending acquisitions and dispositions are subject to numerous conditions and contingencies and there are no assurances that the transactions will be completed.

We have evaluated subsequent events through the date of this filing. We are not aware of any other subsequent events which would require recognition or disclosure in the consolidated financial statements.

 

 

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All dollar amounts in this Form 10-Q in Part I Items 2. through 4 and Part II Items 2. are stated in thousands with the exception of share and per share amounts, unless otherwise indicated.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995

Certain statements contained in this section and elsewhere in this Form 10-Q constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve a number of known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, but are not limited to: (i) trends affecting our financial condition or results of operations; (ii) our business and growth strategies; (iii) the real estate industry; (iv) our financing plans; and other risks detailed in the Company’s other periodic reports filed with the Securities and Exchange Commission. The words “believe”, “expect”, “anticipate”, “may”, “plan”, “should”, and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date the statements were made and are not guarantees of future performance.

Overview

We operate as an Umbrella Partnership Real Estate Investment Trust (UPREIT), which is a REIT that holds all or substantially all of its assets through a partnership which the REIT controls as general partner. Therefore, we hold all or substantially all of our assets through our operating partnership. We control the operating partnership as the sole general partner and own approximately 27.2% of the operating partnership as of June 30, 2014. For purposes of satisfying the asset and income tests for qualification as a REIT for tax purposes, our proportionate shares of the assets and income of our operating partnership are deemed to be assets and income of the trust.

We use this UPREIT structure to facilitate acquisitions of commercial real estate properties. A sale of property directly to a REIT is generally a taxable transaction to the property seller. However, in an UPREIT structure, if a property seller exchanges the property with one of its operating partnerships in exchange for limited partnership units, the seller may defer taxation of gain in such exchange until the seller resells its limited partnership units or exchanges its limited partnership units for the REIT’s common stock. By offering the ability to defer taxation, we may gain a competitive advantage in acquiring desired properties over other buyers who cannot offer this benefit. In addition, investing in our operating partnership, rather than directly in Sterling, may be more attractive to certain institutional or other investors due to their business or tax structure. If an investor is interested in making a substantial investment in our operating partnership, our structure provides us the flexibility to accommodate different terms for each investment, while applicable tax laws generally restrict a REIT from charging different fee rates among its shareholders. Finally, if our shares become publicly traded, the former property seller may be able to achieve liquidity for his investment in order to pay taxes.

Operating Partnership

Our operating partnership, Sterling Properties, LLLP (f/k/a INREIT Properties, LLLP), was formed as a North Dakota limited liability limited partnership on April 25, 2003 to acquire, own and operate properties on our behalf. The operating partnership holds a diversified portfolio of commercial and multi-family properties located principally in the upper and central Midwest United States.

As of June 30, 2014, approximately 65.7% of our properties were apartment communities located primarily in North Dakota with others located in Minnesota and Nebraska. Most multi-family properties are leased to a variety of tenants under short-term leases.

As of June 30, 2014, approximately 34.3% of our properties were comprised of office, retail, industrial and medical commercial property located primarily in North Dakota with others located in Arkansas, Colorado, Iowa, Louisiana, Michigan, Minnesota, Mississippi, Nebraska, Texas and Wisconsin. We have both single and multi-family tenant properties in the commercial portfolio, most of which are under long-term leases.

Our real estate portfolio consisted of 129 properties containing approximately 6,359 apartments and 1,384,000 square feet of leasable commercial space as of June 30, 2014. The portfolio has a net book value of approximately $419,579, which includes construction in progress, and book equity, including noncontrolling interests, of approximately $152,723 as of June 30, 2014.

 

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Our Board of Trustees and Executive Officers

We operate under the direction of our Board of Trustees, the members of which are accountable to our shareholders as fiduciaries. In addition, the Board has a specific fiduciary duty to supervise our relationship with the Advisor, and evaluate the performance of and fees paid to the Advisor on an annual basis prior to renewing the Advisory Agreement with the Advisor. Our Board of Trustees has provided investment guidance for the Advisor to follow, and must approve each investment recommended by the Advisor. Currently, we have nine members on our board, seven of whom are independent of our Advisor. Our trustees are elected annually by our shareholders. Although we have executive officers, we do not have any paid employees.

Our Advisor

Our external Advisor is Sterling Management, LLC, a North Dakota limited liability company formed on November 14, 2002. Our Advisor, with offices in Fargo, North Dakota, is responsible for managing our day-to-day affairs and for identifying, acquiring and disposing investments on our behalf.

Critical Accounting Estimates

Preparation of our financial statements requires estimates and judgments to be made that affect the amounts of assets, liabilities, revenues and expenses reported. Such decisions include the selection of the appropriate accounting principles to be applied and the assumptions on which to base accounting estimates. We evaluate these estimates based on assumptions we believe to be reasonable under the circumstances.

There have been no material changes in our Critical Accounting Policies as disclosed in Note 2 to our financial statements for the six month period ended June 30, 2014 included elsewhere in this report.

Results of Operations for the Three Months Ended June 30, 2014 and 2013

Specific Achievements

 

    Increased revenues from rental operations by $4,816 or 16.3% for the six months ended June 30, 2014, compared to same six month period in 2013.

 

    Acquired seven (7) properties totaling 412 residential apartment units for a total of $20,278 during the six months ended June 30, 2014.

 

    Declared and paid dividends totaling $0.4500 per common share for first and second quarters of 2014.

 

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     Three months ended June 30, 2014     Three months ended June 30, 2013  
     Residential      Commercial      Total     Residential      Commercial      Total  
     (unaudited)     (unaudited)  
     (in thousands)     (in thousands)  

Real Estate Revenues

   $ 12,909       $ 4,353       $ 17,262      $ 10,221       $ 4,672       $ 14,893   

Real Estate Expenses

                

Real Estate Taxes

     1,028         234         1,262        981         641         1,622   

Property Management Fees

     1,537         73         1,610        1,180         74         1,254   

Utilities

     1,201         209         1,410        875         202         1,077   

Repairs and Maintenance

     2,493         181         2,674        1,314         201         1,515   

Insurance

     388         14         402        241         14         255   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total Real Estate Expenses

     6,647         711         7,358        4,591         1,132         5,723   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Net Operating Income

   $ 6,262       $ 3,642       $ 9,904      $ 5,630       $ 3,540       $ 9,170   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Interest

           3,082              2,661   

Depreciation and amortization

           3,377              2,962   

Administration of REIT

           1,310              1,270   

Other (income)/expense

           (659           (198
        

 

 

         

 

 

 

Income from continuing operations

           2,794              2,475   
        

 

 

         

 

 

 

Discontinued operations

           —                281   
        

 

 

         

 

 

 

Net Income

         $ 2,794            $ 2,756   
        

 

 

         

 

 

 

Net Income Attributed to:

                

Noncontrolling Interest

         $ 2,017            $ 1,922   

Sterling Real Estate Trust

         $ 777            $ 834   

Dividends per share (1)

         $ 0.2250            $ 0.2100   

Earnings per share

         $ 0.14            $ 0.16   

Weighted average number of common shares

           5,443              5,353   

 

(1)  Does not take into consideration the amounts distributed by the operating partnership to limited partners.

Revenues

Property revenues of approximately $17,262 for the three months ended June 30, 2014 increased approximately $2,369 or 15.9% in comparison to the same period in 2013. Residential property revenues increased approximately $2,688 while commercial property revenues decreased approximately $319.

The following table illustrates quarterly changes in occupancy for the periods indicated:

 

     June 30,     June 30,  
     2014     2013  

Residential occupancy

     97.1     97.8

Commercial occupancy

     98.8     98.9

Residential revenues for the three month period ended June 30, 2014 increased $2,688 in comparison to the same period for 2013. Approximately $2,490 of the increase was due to residential properties acquired since January 1, 2013. Rental income from residential properties owned for more than one year increased approximately $198 in comparison to the same period in 2013. Residential revenues comprised 74.8% of total revenues for the three month period ended June 30, 2014 compared to 68.6% of total revenues for the three month period ended June 30, 2013.

For the three month period ended June 30, 2014 total commercial revenues decreased $319 in comparison to the same period for 2013. The overall decrease includes an increase in revenues of approximately $99 from commercial properties acquired since January 1, 2013. Rental income from commercial properties owned for more than one year decreased approximately $418 in comparison to the same period in 2013 primarily due to decreased CAM income (common area maintenance). Commercial revenues comprised 25.2% of the total revenues for the three month period ended June 30, 2014 compared to 31.4% of total revenues for the three month period ended June 30, 2013.

 

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Expenses

Residential expenses from operations of $6,647 during the three month period ended June 30, 2014 increased $2,056 or 44.8% in comparison to the same period in 2013. This increase was primarily attributed to the increase in number of residential properties owned during the three month period ended June 30, 2014 versus the same period in 2013.

Commercial expenses from operations of $711 during the three month period ended June 30, 2014 decreased $421 or 37.2% in comparison to the same period in 2013. This decrease was in part attributed to real estate tax relief in North Dakota. In addition, the decrease was in part attributed to decreases in real estate tax expense which corresponds to the decrease in commercial CAM income.

Interest expense of $3,082 during the three month period ended June 30, 2014 increased $421 in comparison to the same period in 2013. Interest expense was approximately 17.9% and 17.9% of rental income for three month periods ended June 30, 2014 and 2013, respectively.

Depreciation and amortization expense increased 14.0% from $2,962 for the three months ended June 30, 2013 to approximately $3,377 for the three months ended June 30, 2014. The $415 increase was primarily a result of depreciation and amortization for the 15 properties added to our portfolio since June 30, 2013. Depreciation and amortization expense as a percentage of rental income for the three month periods ended June 30, 2014 and 2013 was relatively consistent at 19.6% and 19.9%, respectively.

REIT administration expenses increased from $1,270 for the three months ended June 30, 2013 to $1,310 for the three month periods ended June 30, 2014 due to an increase in advisory fees expenses related to increased asset balance during the second quarter of 2014 in comparison to the same period in 2013.

Net Operating Income

We measure the performance of our segments based on net operating income (“NOI”), which we define as total revenue from rental operations less expenses from rental operations and real estate taxes (excluding depreciation and amortization related to real estate investments and impairment of real estate investments). We believe that NOI is an important supplemental measure of operating performance for a REIT because it provides a measure of core operations unaffected by depreciation, amortization, financing, and administration expense. NOI does not represent cash generated by operating activities in accordance with GAAP and should not be considered an alternative to net income, net income available for non-controlling interests and shareholders of the Trust or cash flow from operating activities as a measure of financial performance.

Residential NOI increased $632 or 11.2% for the three month period ended June 30, 2014 in comparison to the same three month period in 2013 due primarily to acquisition activity in the residential segment. Commercial NOI increased $102 or 2.9% for the three month period ended June 30, 2014 in comparison to the same three month period in 2013 due primarily to lower real estate tax expense in the commercial segment.

Net Income

Our net income continues to grow however, it was impacted by the sale of the senior living property in October 2013.

 

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Results of Operations for the Six Months Ended June 30, 2014 and 2013

 

     Six months ended June 30, 2014     Six months ended June 30, 2013  
     Residential      Commercial      Total     Residential      Commercial      Total  
     (unaudited)     (unaudited)  
     (in thousands)     (in thousands)  

Real Estate Revenues

   $ 25,525       $ 8,821       $ 34,346      $ 20,150       $ 9,380       $ 29,530   

Real Estate Expenses

                

Real Estate Taxes

     2,085         492         2,577        1,929         1,293         3,222   

Property Management Fees

     3,019         149         3,168        2,290         144         2,434   

Utilities

     2,670         447         3,117        1,861         411         2,272   

Repairs and Maintenance

     4,616         409         5,025        2,500         400         2,900   

Insurance

     772         28         800        470         29         499   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total Real Estate Expenses

     13,162         1,525         14,687        9,050         2,277         11,327   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Net Operating Income

   $ 12,363       $ 7,296       $ 19,659      $ 11,100       $ 7,103       $ 18,203   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Interest

           6,146              5,354   

Depreciation and amortization

           6,732              5,801   

Administration of REIT

           2,354              2,767   

Other (income)/expense

           (1,232           (376
        

 

 

         

 

 

 

Income from continuing operations

           5,659              4,657   
        

 

 

         

 

 

 

Discontinued operations

           —                530   
        

 

 

         

 

 

 

Net Income

         $ 5,659            $ 5,187   
        

 

 

         

 

 

 

Net Income Attributed to:

                

Noncontrolling Interest

         $ 4,085            $ 3,606   

Sterling Real Estate Trust

         $ 1,574            $ 1,581   

Dividends per share (1)

         $ 0.4500            $ 0.4200   

Earnings per share

         $ 0.29            $ 0.30   

Weighted average number of common shares

           5,441              5,334   

 

(1) Does not take into consideration the amounts distributed by the operating partnership to limited partners.

Revenues

Property revenues of approximately $34,346 for the six months ended June 30, 2014 increased approximately $4,816 or 16.3% in comparison to the same period in 2013. Residential property revenues increased approximately $5,375 while commercial property revenues decreased approximately $559.

The following table illustrates quarterly changes in occupancy for the periods indicated:

 

     June 30,     June 30,  
     2014     2013  

Residential occupancy

     97.1     98.0

Commercial occupancy

     99.1     99.1

Residential revenues for the six month period ended June 30, 2014 increased $5,375 in comparison to the same period for 2013. Approximately $4,910 of the increase was due to residential properties acquired since January 1, 2013. Rental income from residential properties owned for more than one year increased approximately $465 in comparison to the same period in 2013. Residential revenues comprised 74.3% of total revenues for the six month period ended June 30, 2014 compared to 68.2% of total revenues for the six month period ended June 30, 2013.

For the six month period ended June 30, 2014 commercial revenues decreased $559 in comparison to the same period for 2013. The decrease is despite an increase in revenues of approximately $265 from commercial properties acquired since January 1, 2013. Rental income from commercial properties owned for more than one year decreased approximately $824 in comparison to the same period in 2013 primarily due to decreased CAM income (common area maintenance). Commercial revenues comprised 25.7% of the total revenues for the six month period ended June 30, 2014 compared to 31.8% of total revenues for the six month period ended June 30, 2013.

 

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Expenses

Residential expenses from operations of $13,162 during the six month period ended June 30, 2014 increased $4,112 or 45.4% in comparison to the same period in 2013. This increase was primarily attributed to the increase in number of residential properties owned during the six month period ended June 30, 2014 versus the same period in 2013.

Commercial expenses from operations of $1,525 during the six month period ended June 30, 2014 decreased $752 or 33.0% in comparison to the same period in 2013. This decrease was in part attributed to real estate tax relief in North Dakota. In addition, the decrease was in part attributed to decreases in real estate tax expense which corresponds to the decrease in commercial CAM income.

Interest expense of $6,146 during the six month period ended June 30, 2014 increased $792 in comparison to the same period in 2013. Interest expense was approximately 17.9% and 18.1% of rental income for six month periods ended June 30, 2014 and 2013, respectively. The decrease of interest expense as a percentage of rental income during the six month period ended June 30, 2014 was a result of lower interest rates for mortgage notes payable during this period in 2014 compared to the same period in 2013 and increased rental revenues from acquired properties unencumbered by mortgages.

Depreciation and amortization expense increased 16.0% from $5,801 for the six months ended June 30, 2013 to approximately $6,732 for the six months ended June 30, 2014. The $931 increase was primarily a result of depreciation and amortization for the 15 properties added to our portfolio since June 30, 2013. Depreciation and amortization expense as a percentage of rental income for the six month periods ended June 30, 2014 and 2013 was consistent at 19.6% for both periods.

REIT administration expenses decreased from $2,767 for the six months ended June 30, 2013 to $2,354 for the six month periods ended June 30, 2014 due to a decrease in acquisition expenses related to less acquisition activity during the first quarter of 2014 in comparison to the same period in 2013.

Net Operating Income

We measure the performance of our segments based on net operating income (“NOI”), which we define as total revenue from rental operations less expenses from rental operations and real estate taxes (excluding depreciation and amortization related to real estate investments and impairment of real estate investments). We believe that NOI is an important supplemental measure of operating performance for a REIT because it provides a measure of core operations unaffected by depreciation, amortization, financing, and administration expense. NOI does not represent cash generated by operating activities in accordance with GAAP and should not be considered an alternative to net income, net income available for non-controlling interests and shareholders of the Trust or cash flow from operating activities as a measure of financial performance.

Residential NOI increased $1,263 or 11.4% for the six month period ended June 30, 2014 in comparison to the same six month period in 2013 due primarily to acquisition activity in the residential segment. Commercial NOI increased $193 or 2.7% for the six month period ended June 30, 2014 in comparison to the same six month period in 2013 due primarily to lower real estate tax expense in the commercial segment.

Net Income

Our net income continues to grow however, it was impacted by the sale of the senior living property in October 2013.

Property Acquisitions and Dispositions

Property Acquisitions and Dispositions during the six month period ended June 30, 2014

We acquired seven properties for a total of $20,278 during the first six months of 2014. Total consideration for the acquisitions was the issuance of approximately $14,396 in limited partnership units of the operating partnership, assumed loans of $1,580, assume liabilities and deferred maintenance of $167 and cash of $4,135.

During the second quarter of 2014, there were no dispositions.

 

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Property Acquisitions and Dispositions during the six month period ended June 30, 2013

We acquired thirteen properties for a total of $32,350 during the first six months of 2013. Total consideration for the acquisitions was the issuance of approximately $17,555 in limited partnership units of the operating partnership and cash of $14,795.

During the second quarter of 2013, we sold a parcel of land for a total of $276 and recognized a $42 gain on the sale.

See Notes 19 and 20 to the Consolidated Financial Statements included above for more information regarding our acquisitions and dispositions during the six month periods ended June 30, 2014 and 2013.

Funds From Operations and Modified Funds From Operations (FFO and MFFO)

Funds From Operations (FFO) applicable to common shares and limited partnership units means net income (computed in accordance with GAAP), excluding gains (or losses) from sales of property, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. Adjustments for unconsolidated partnerships and joint ventures will be calculated to reflect funds from operations on the same basis.

Historical cost accounting for real estate assets implicitly assumes the value of real estate assets diminishes predictably over time. Since real estate values have historically risen or fallen with market conditions, many industry investors have considered presentations of operating results for real estate companies use historical cost accounting to be insufficient by themselves. The term Funds From Operations (FFO) was created to address this problem. It was intended to be a standard supplemental measure of REIT operating performance that excluded historical cost depreciation from — or “added it back” to — GAAP net income.

Our management believes this non-GAAP measure is useful to investors because it provides supplemental information that facilitates comparisons to prior periods and for the evaluation of financial results. Management uses this non-GAAP measure to evaluate our financial results, develop budgets and manage expenditures. The method used to produce non-GAAP results is not computed according to GAAP, is likely to differ from the methods used by other companies and should not be regarded as a replacement for corresponding GAAP measures. Management encourages the review of the reconciliation of this non- GAAP financial measure to the comparable GAAP results.

Since the introduction of the definition of FFO, the term has come to be widely used by REITs. In the view of National Association of Real Estate Investment Trusts (“NAREIT”), the use of the definition of FFO (combined with the primary GAAP presentations required by the Securities and Exchange Commission) has been fundamentally beneficial, improving the understanding of operating results of REITs among the investing public and making it easier than before to compare the results of one REIT with another.

In addition to FFO, management also uses Modified Funds From Operations (“MFFO”) as a non-GAAP supplemental performance measure. MFFO as defined by us excludes from FFO acquisition related costs which are required to be expensed in accordance with GAAP. Our definition of MFFO also excludes disposition costs related to sales of investment properties. Acquisition and disposition related expenses include those paid to our Advisor and third parties. Management believes that excluding acquisition and disposition related costs from MFFO provides useful supplemental performance information that is comparable over the long-term and this is consistent with management’s analysis of the operating performance of the REIT.

While FFO and MFFO applicable to common shares and limited partnership units are widely used by REITs as performance metrics, all REITs do not use the same definition of FFO and MFFO or calculate FFO and MFFO in the same way. The FFO and MFFO reconciliation presented here is not necessarily comparable to FFO and MFFO presented by other real estate investment trusts. FFO and MFFO should also not be considered as an alternative to net income as determined in accordance with GAAP as a measure of a real estate investment trust’s performance, but rather should be considered as an additional, supplemental measure, and should be viewed in conjunction with net income as presented in the consolidated financial statements included in this report. FFO and MFFO applicable to common shares and limited partnership units does not represent cash generated from operating activities in accordance with GAAP, and is not necessarily indicative of sufficient cash flow to fund a real estate investment trust’s needs or its ability to service indebtedness or to pay dividends to shareholders.

 

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The following tables include calculations of FFO and MFFO, and the reconciliations to net income, for the three and six months ended June 30, 2014 and 2013, respectively. We believe these calculations are the most comparable GAAP financial measure (in thousands):

Reconciliation of Net Income Attributable to Sterling to FFO and MFFO Applicable to Common Shares and Limited Partnership Units

 

     Three months ended June 30, 2014      Three months ended June 30, 2013  
                   Per                   Per  
            Weighted Avg      Share and            Weighted Avg      Share and  
     Amount      Shares and Units(1)      Unit(2)      Amount     Shares and Units(1)      Unit(2)  
     (unaudited)  
     (in thousands, except per share data)  

Net Income attributable to Sterling Real Estate Trust

   $ 777         5,443       $ 0.14       $ 834        5,353       $ 0.16   

Add back:

                

Noncontrolling Interest—OPU

     2,015         14,091            1,913        12,155      

Depreciation & Amortization from continuing operations

     3,377               2,962        

Depreciation & Amortization from discontinued operations

     —                 181        

Pro rata share of unconsolidated affiliate depreciation & amortization

     122               102        

Loss on depreciable asset sales

     —                 —          

Loss on impairment of property

     —                 —          

Subtract:

                

(Gains) loss on land and depreciable asset sales

     —                 (42     
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Funds from operations applicable to common shares and limited partnership units

     6,291         19,534       $ 0.32         5,950        17,508       $ 0.34   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Add back:

                

Acquisition and disposition expenses

     689               700        
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Modified Funds from Operations (MFFO)

   $ 6,980         19,534       $ 0.36       $ 6,650        17,508       $ 0.38   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) Please see Note 11 to the consolidated financial statements included above for more information.
(2) Net Income is calculated on a per share basis. FFO is calculated on a per share and unit basis.

 

     Six months ended June 30, 2014      Six months ended June 30, 2013  
                   Per                   Per  
            Weighted Avg      Share and            Weighted Avg      Share and  
     Amount      Shares and Units(1)      Unit(2)      Amount     Shares and Units(1)      Unit(2)  
     (in thousands, except per share data)  

Net Income attributable to Sterling Real Estate Trust

   $ 1,574         5,441       $ 0.29       $ 1,581        5,334       $ 0.30   

Add back:

                

Noncontrolling Interest—OPU

     4,076         13,997            3,589        11,992      

Depreciation & Amortization from continuing operations

     6,732               5,801        

Depreciation & Amortization from discontinued operations

     —                 361        

Pro rata share of unconsolidated affiliate depreciation & amortization

     243               204        

Loss on depreciable asset sales

     —                 —          

Loss on impairment of property

     —                 —          

Subtract:

                

(Gains) loss on land and depreciable asset sales

     —                 (42     
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Funds from operations (FFO) applicable to common shares and limited partnership units

     12,625         19,438       $ 0.65         11,494        17,326       $ 0.66   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Add back:

                

Acquisition and disposition expenses

     1,050               1,588        
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Modified Funds from operations (MFFO)

   $ 13,675         19,438       $ 0.70       $ 13,082        17,326       $ 0.76   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) Please see Note 11 to the consolidated financial statements included above for more information.
(2) Net Income is calculated on a per share basis. FFO is calculated on a per share and unit basis.

 

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Liquidity and Capital Resources

Our principal demands for funds will be for the (i) acquisition of real estate and real estate-related investments, (ii) payment of acquisition related expenses and operating expenses, (iii) payment of dividends/distributions and repurchases, and (iv) payment of principal and interest on current and any future outstanding indebtedness. Generally, we expect to meet cash needs for the payment of operating expenses and interest on outstanding indebtedness from cash flow from operations. We expect to pay dividends/distributions and any repurchase requests to our shareholders and the unit holders of our operating partnership from cash flow from operations; however, we may use other sources to fund dividends/distributions and repurchases, as necessary. We expect to meet cash needs for acquisitions and other real-estate investments from cash flow from operations, net proceeds of share offerings and debt proceeds.

Evaluation of Liquidity

We continually evaluate our liquidity and ability to fund future operations, debt obligations and any repurchase requests. As part of our analysis, we consider among other items, credit quality of tenants and lease expirations.

Credit Quality of Tenants

We are exposed to credit risk within our tenant portfolio, which can reduce our results of operations and cash flow from operations if our tenants are unable to pay their rent. Tenants experiencing financial difficulties may become delinquent on their rent or default on their leases and, if they file for bankruptcy protection, may reject our lease in bankruptcy court, resulting in reduced cash flow. This may negatively impact net asset values and require us to incur impairment charges. Even if a default has not occurred and a tenant is continuing to make the required lease payments, we may restructure or renew leases on less favorable terms, or the tenant’s credit profile may deteriorate, which could affect the value of the leased asset and could in turn require us to incur impairment charges.

Historically, the geographic location of our properties and credit-worthiness of our tenants have resulted in minimal to no property impairments or write-offs on uncollectible rental revenues. We currently anticipate the trend to continue. It is possible, however, that tenants may file for bankruptcy or default on their leases in the future and that economic conditions may deteriorate.

To mitigate credit risk on commercial properties, we have historically looked to invest in assets that we believe are critically important to our tenant’s operations and have attempted to diversify our portfolio by tenant, tenant industry and geography. We also monitor all of our properties performance through review of rent delinquencies as a precursor to a potential default, meetings with tenant management and review of tenants’ financial statements and compliance with financial covenants. When necessary, our asset management process includes restructuring transactions to meet the evolving needs of tenants, refinancing debt and selling properties, as well as protecting our rights when tenants default or enter into bankruptcy.

Lease Expirations and Occupancy

No significant leases are scheduled to expire or renew in the next twelve months. The Advisor, with the assistance of our property managers, actively manages our real estate portfolio and begins discussing options with tenants in advance of scheduled lease expirations. In certain cases, we may obtain lease renewals from our tenants; however, tenants may elect to move out at the end of their term. In the cases where tenants elect not to renew, we may seek replacement tenants or try to sell the property.

 

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Cash Flow Analysis

Our objectives are to generate sufficient cash flow over time to provide shareholders with increasing dividends and to seek investments with potential for strong returns and capital appreciation throughout varying economic cycles. We have funded 100% of the dividends from operating cash flows. In setting a dividend rate, we focus primarily on expected returns from investments we have already made to assess the sustainability of a particular dividend rate over time.

 

     Six Months Ended  
     June 30,  
     2014     2013  
     (in thousands)  

Net cash flows provided by operating activities

   $ 6,072      $ 12,638   

Net cash flows used in investing activities

   $ (9,733   $ (17,872

Net cash flows provided by (used in) financing activities

   $ (9,403   $ 4,180   

Operating Activities

Our real estate properties generate cash flow in the form of rental revenues, which is reduced by interest payments, direct leases costs and property-level operating expenses. Property-level operating expenses consist primarily of property management fees including salaries and wages of property management personnel, utilities, cleaning, repairs, insurance, security and building maintenance costs, and real estate taxes. Additionally, we incur general and administrative expenses, advisory fees, acquisition and disposition expenses, and financing and development fees.

Net cash provided by operating activities was $6,072 and $12,638 for the six months ended June 30, 2014 and 2013, respectively, which consists primarily of net income from property operations adjusted for non-cash depreciation and amortization. The funds generated for the six months ended June 30, 2014 and 2013 were primarily from property operations of our real estate portfolio. In addition during the six months ended June 30, 2014, we invested $7,152 in marketable securities consisting of real estate backed equity securities.

Investing Activities

Our investing activities generally consist of real estate-related transactions (purchases and sales of properties) and payments of capitalized property-related costs such as intangible assets and real estate tax and insurance escrows.

Net cash used in investing activities was $9,733 and $17,872 for the six months ended June 30, 2014 and 2013, respectively (this does not include the value of UPREIT units issued in connection with investing activities). For the six months ended June 30, 2014 and 2013, cash flows used in investing activities related primarily to the acquisition of properties and capital expenditures was $7,840 and $15,924, respectively, and the change in restricted cash for real estate tax, insurance and replacement reserve escrows was $2,045 and $2,533, respectively.

Financing Activities

Our financing activities generally consist of funding property purchases by raising proceeds and securing mortgage notes payable as well as paying dividends, paying syndication costs and making principal payments on mortgage notes payable.

Net cash used in financing activities was $9,403 for the six months ended June 30, 2014. Net cash provided by financing activities was $4,180 for the six months ended June 30, 2013. During the six months ended June 30, 2014, we paid approximately $6,773 in dividends and distributions, repurchased $3,812 of shares and units, received proceeds from new mortgage notes payable of approximately $2,863, and $1,422 in borrowings under our lines of credit, and made mortgage principal payments of approximately $3,835. For the six months ended June 30, 2013, we paid approximately $5,799 in dividends and distributions, repurchased $2,126 of shares and units, received proceeds from new mortgage notes payable of approximately $19,010, and $6,001 in borrowings under our lines of credit, and made mortgage principal payments of approximately $12,934.

 

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Dividends

Common Stock

We declared cash dividends to our shareholders during the period from January 1, 2014 to June 30, 2014 totaling $2,436 or $0.4500 per share, including amounts reinvested through the dividend reinvestment plan. During the six months ended June 30, 2014, we paid cash dividends of $795 and dividends of $1,641 were reinvested under the dividend reinvestment plan. The cash dividends were paid with the $6,072 from our cash flows from operations and $632 provided by distributions from unconsolidated affiliates.

We declared cash dividends to our shareholders during the period from January 1, 2013 to June 30, 2013 totaling $2,235 or $0.4200 per share, including amounts reinvested through the dividend reinvestment plan. During the six months ended June 30, 2013, we paid cash dividends of $904 and dividends of $1,331 were reinvested under the dividend reinvestment plan. The cash dividends were paid with the $12,638 from our cash flows from operations and $420 provided by distributions from unconsolidated affiliates.

We continue to provide cash dividends to our shareholders from cash generated by our operations. The following chart summarizes the sources of our cash used to pay dividends. Our primary source of cash is cash flow provided by operating activities from our investments as presented in our cash flow statement. We also include distributions from unconsolidated affiliates to the extent that the underlying real estate operations in these entities generate these cash flows and the gain on sale of properties relates to net profits from the sale of certain properties. Our presentation is not intended to be an alternative to our consolidated statement of cash flows and does not present all sources and uses of our cash.

The following table presents certain information regarding our dividend coverage:

 

     Six Months Ended  
     June 30,  
     2014     2013  
  

 

 

   

 

 

 
     (in thousands)  

Cash flows provided by operations

  

(includes net income of $5,659 and $5,187, respectively)

   $ 6,072      $ 12,638   

Distributions from unconsolidated affiliates

     632        420   

Gain on sales of properties

     —          37   

Dividends declared

     (2,436     (2,235
  

 

 

   

 

 

 

Excess

   $ 4,268      $ 10,860   
  

 

 

   

 

 

 

Limited Partnership Units

The operating partnership agreement provides that our operating partnership will distribute to the partners (subject to certain limitations) cash from operations on a quarterly basis (or more frequently, if we so elect) in accordance with the percentage interests of the partners. We determine the amounts of such distributions in our sole discretion.

For the six months ended June 30, 2014, we declared and paid distributions of $6,387 to holders of limited partnership units in our operating partnership. Distributions were paid at a rate of $0.4500 per unit, which is equal to the per share distribution rate paid to the common shareholders. As of June 30, 2014, the limited partnership declared distributions of $3,263 which represented distributions for the quarter ended June 30, 2014, and we paid such amount on July 15, 2014.

For the six months ended June 30, 2013, we declared and paid distributions of $5,125 to holders of limited partnership units in our operating partnership. Distributions were paid at a rate of $0.4200 per unit, which is equal to the per share distribution rate paid to the common shareholders. As of June 30, 2013, the limited partnership declared distributions of $2,586 which represented distributions for the quarter ended June 30, 2013, and we paid such amount on July 15, 2013.

 

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Sources of Dividends

For the six months ended June 30, 2014, we paid aggregate dividends of $2,436, which were paid 100% from cash flows provided by operating activities. Our funds from operations, or FFO, was $12,625 while our modified funds from operations, or MFFO, as of the six months ended June 30, 2014 was $13,675; therefore our management believes our distribution policy is sustainable over time. For the six months ended June 30, 2013, we paid aggregate dividends of $2,235 which were paid 100% from cash flows provided by operating activities. Our FFO was $11,494 while our MFFO, as of the six months ended June 30, 2013 was $13,082. For a further discussion of FFO and MFFO, including a reconciliation of FFO and MFFO to net income, see “Funds from Operations and Modified Funds from Operations” above.

Cash Resources

At June 30, 2014, our cash resources consisted of cash and cash equivalents totaling approximately $785. In addition, we had unencumbered properties with a gross book value of $47,697, which could potentially be used as collateral to secure additional financing in future periods. We also had marketable securities totaling approximately $7,676, which could be used for operations or acquisitions in future periods.

We also have four lines of credit: (i) a $15,000 line of credit with Wells Fargo Bank (which expires in July 2015) secured by an office property in Duluth, Minnesota, four retail properties in Minnesota, one retail property in Texas, and four retail properties in North Dakota (ii) a $1,000 unsecured line of credit (which expires in October 2014) (iii) a $3,000 line of credit (which expires November 2014) with Bremer Bank secured by two commercial properties in Moorhead, Minnesota and an office property in St. Cloud, Minnesota and (iv) a $2,660 line of credit with Bell State Bank & Trust secured by a multi-family property in Fargo, North Dakota, which expires in April 2015. As of June 30, 2014, there was $1,422 outstanding on the Bremer secured line of credit. As of December 31, 2013, there were no balances outstanding on the lines of credit.

In connection with our construction in progress, the Company anticipates obtaining an additional $10,000 line of credit. We presently expect the terms of the line of credit to be for 24 months with a variable interest rate based on 1-month LIBOR plus 2.5%, then subsequent to the initial period, rolling into a 5 year amortizing loan. The line will be used as needed to fund the construction of the residential project currently in process.

Our cash resources can be used for working capital needs and other commitments. Our lines of credit and certain mortgage note agreements include covenants that, in part, impose maintenance of certain debt service coverage and debt to worth ratios. As of June 30, 2014 we were in compliance with all covenants with the exception of one loan on a residential property in Fargo, North Dakota with an outstanding principal balance of $2,338 at June 30, 2014. The property has scheduled deferred maintenance at an estimated cost of $15 to be completed in the fall of 2014. As of June 30, 2014, the uncompleted repairs required under the loan constitute non-compliance. However, subsequent to quarter end, an extension was obtained through December 31, 2014, in which the lender has agreed to forebear any remedies pending the completion of the repairs. As of December 31, 2013, we were in compliance with all covenants.

The issuance of limited partnership units of the operating partnership in exchange for property acquisitions and sale of additional common or preferred shares is also expected to be a source of long-term capital for us. During the six months ended June 30, 2014, we did not sell any common shares in private placements. During the six months ended June 30, 2014, we issued 114,000 and 56,000 common shares under the dividend reinvestment plan, through dividends reinvested and the optional share purchases, respectively and raised gross proceeds of $2,379. During the six months ended June 30, 2013, we did not sell any common shares in private placements. During the six months ended June 30, 2013, we issued 102,000 and 29,000 common shares under the dividend reinvestment plan, through dividends reinvested and the optional share repurchases, respectively and raised gross proceeds of $1,764.

During the six months ended June 30, 2014, we issued limited partnership units valued at approximately $14,396 in connection with the acquisition of seven properties.

During the six months ended June 30, 2013, we issued limited partnership units valued at approximately $17,555 in connection with the acquisitions of thirteen properties.

Off-Balance Sheet Arrangements

As of June 30, 2014 and December 31, 2013, we had no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

 

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Item 4. Controls and Procedures.

Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Accounting Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Accounting Officer have concluded that, as of June 30, 2014, such disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and is accumulated and communicated to management, including our principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Controls over Financial Reporting

There were no changes in our internal controls over financial reporting that occurred during the second fiscal quarter of 2014 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II

OTHER INFORMATION

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

Sale of Securities

Neither Sterling nor the operating partnership issued any unregistered securities during the three month period ended June 30, 2014, except as described below:

In connection with the completion of the acquisition of certain contributed properties, the operating partnership issued units as a portion of the purchase price, at a price per unit, as applicable, of $14, as set forth in the table below, during the three month period ended June 30, 2014 (in thousands, except per unit data) pursuant to Section 4(2) and Rule 506 of Regulation D.

 

     Property                
     Acquisition      Number of      Aggregate  

Property

   Date      Units      Consideration  

Eagle Run Apartments, West Fargo, ND

     05/01/14         49,286       $ 690   

Griffin Court Apartments, Moorhead, MN

     06/09/14         278,990         3,906   

Parkwest Gardens Apartments, West Fargo, ND

     06/30/14         317,749         4,448   
     

 

 

    

 

 

 
        646,025       $ 9,044   

Other Sales

During the three months ended June 30, 2014, we issued 1,520 common shares in exchange for limited partnership units of the operating partnership on a one-for-one basis pursuant to redemption requests made by accredited investors pursuant to Section 4(2) and Rule 506 of Regulation D. The issuances during the three months ended June 30, 2014 were as set forth below:

 

     Total  
     Number of Common  

Period

   Shares Exchanged  

April 1-30, 2014

     —     

May 1-31, 2014

     1,520   

June 1-30, 2014

     —     
  

 

 

 
     1,520   

Redemptions of Securities

Set forth below is information regarding common shares and limited partnership units redeemed during the three months ended June 30, 2014:

 

                                        Shares (and  
                                        Maximum Number (or  
                   Average      Total Number of      Total Number of      Approximate Dollar Value) of  
     Total Number      Total Number      Price      Shares Redeemed      Units Redeemed      Shares (or Units) that May  
     of Common      of Limited      Paid per      as Part of      as Part of      Yet Be Redeemed Under  
     Shares      Partner Units      Common      Publicly Announced      Publicly Announced      Publicly Announced  

Period

   Redeemed      Redeemed      Share/Unit      Plans or Programs      Plans or Programs      the Plans or Programs  

April 1-30, 2014

     23,000         16,000       $ 14.00         743,000         469,000       $ 14,201,000   

May 1-31, 2014

     28,000         7,000       $ 14.00         771,000         476,000       $ 13,705,000   

June 1-30, 2014

     19,000         1,000       $ 14.00         790,000         477,000       $ 13,412,000   
  

 

 

    

 

 

             

Total

     70,000         24,000               

For the three months ended June 30, 2014, we redeemed all shares or units for which we received redemption requests. In addition, for the three months ended June 30, 2014, all common shares and units redeemed were redeemed as part of the publicly announced plans.

 

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On March 28, 2013, September 26, 2013 and March 27, 2014 our Board of Trustees revised the Share Redemption Plan and Unit Redemption Plan. The amended and restated Share Redemption Plan and Unit Redemption Plan permits us to repurchase common shares held by our shareholders and limited partnership units held by members of our operating partnership, up to a maximum amount of $30,000 worth of shares and units, upon request by the holders after they have held them for at least one year and subject to other conditions and limitations described in the plan. The redemption price for such shares and units redeemed under the plan was fixed at $13.00 per share or unit, which was increased to $14.00 effective October 16, 2013 and is the current redemption price. The redemption plan will terminate in the event the shares become listed on any national securities exchange, the subject of bona fide quotes on any inter-dealer quotation system or electronic communications network or are the subject of bona fide quotes in the pink sheets. Additionally, the Board, in its sole discretion, may terminate, amend or suspend the redemption plans at any time in its sole discretion.

 

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Item 6. Exhibits.

 

Exhibit
Number

  

Title of Document

31.1    Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2    Certification of the Chief Accounting Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1    Certification of Chief Executive Officer and Chief Accounting Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the of the Sarbanes-Oxley Act of 2002.
101    The following materials from Sterling Real Estate Trust’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2014, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets at June 30, 2014 and December 31, 2013; (ii) Consolidated Statements of Operations and Other Comprehensive Income for the three and six months ended June 30, 2014 and 2013; (iii) Consolidated Statement of Shareholders’ Equity for six months ended June 30, 2014; (iv) Consolidated Statements of Cash Flows for the six months ended June 30, 2014 and 2013, and; (v) Notes to Consolidated Financial Statements.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused the report to be signed on its behalf by the undersigned, thereunto duly authorized.

Dated: August 13, 2014

 

STERLING REAL ESTATE TRUST
By:   /s/ Kenneth P. Regan
  Kenneth P. Regan
  Chief Executive Officer
  (Principal Executive Officer)
By:   /s/ Angie D. Stock
  Angie D. Stock
  Chief Accounting Officer
  (Principal Financial and Accounting Officer)